If you sell CSL Limited now, you might regret it

Should you buy this stock for its long term income potential?

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CSL Limited (ASX: CSL) may not be considered a top income stock by most investors. That's understandable, since it yields 1.6% versus 4.1% for the ASX. It's even further behind popular income stocks such as Telstra Corporation Ltd (ASX: TLS) and Westpac Banking Corp (ASX: WBC), which have yields of 5.8% and 6.2% respectively. However, this week's full year results release from CSL indicates that its dividend growth prospects are strong.

Seqirus

Although CSL's influenza vaccine business, Seqirus, was loss-making in financial year 2016, its turnaround plan is on-track and it is forecast to breakeven in financial year 2018. Beyond that, it has real growth potential owing to the efficiencies which will be generated from an integration programme, as well as a sharing of best practices between CSL and the former Novartis influenza business.

Seqirus recently launched two new products following FDA approval. Fluad and Flucelvax Quadrivalent will have a full-year impact from 2018 onwards. Further, the 2015/16 winter saw a relatively mild influenza season, which negatively impacted on demand for vaccines. Investment in Seqirus' facilities such as a new formulation facility will act as an additional catalyst on its financial performance.

Finances

The purchase of Seqirus pushed CSL's debt levels higher in financial year 2016. However, CSL has modest debt levels, as evidenced by interest cover of 32x. This indicates that debt levels can rise to fund future growth, while cash flow can be increasingly used to pay higher dividends. Clearly, CSL's R&D investment is relatively high at US$614 million, but free cash flow of US$684 million was sufficient to cover dividends 1.2 times in the 2016 financial year.

CSL will consider a new $500 million share buyback once the current $1 billion programme has ended. However, it also intends to raise US$500 million as part of its overall capital management programme. Borrowing rates are at an historic low for CSL and will fund investment which could boost dividends in the long run.

Business model

Although CSL is undergoing a period of major change as its Seqirus segment experiences a transformation, its business model is stable. This appeals to income-seeking investors because it reduces the risk of dividend payments not being met. For example, CSL is geographically diversified and its biggest market of North America accounts for 46% of its sales. Similarly, its biggest product portfolio of Immunoglobins accounts for 42% of its sales.

Of course, CSL's relatively low yield and P/E ratio of 32.5 (versus 18 for the ASX) may cause investors to doubt its appeal. However, its dividend growth potential and diversified business model mean that it should appeal to long term income investors.

Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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