Shares of bio-pharmaceutical giant, CSL Limited (ASX: CSL), have been under serious pressure over the last three months and, perhaps to the surprise of some investors, have underperformed the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) by nearly 13%.
Although this pull-back is insignificant in the context of the longer term returns generated by CSL, some investors may wonder what is behind the recent period of weakness and could there be further falls to come.
One of the biggest reasons for the ongoing share price weakness has been the result of the company missing earnings expectations. Although CSL's latest full year result was far from being terrible, the result certainly missed analyst and market expectations. Underlying net profit after tax (NPAT) increased by just 5% and reported profit actually fell by 11% thanks to the loss making contribution from Seqirus, the recently acquired influenza business from Novartis.
The performance of the Seqirus business, in particular, has come under the spotlight after it recorded an operating net loss of US$205 million and booked in US$87 million in restructuring costs. Although CSL has previously informed the market that the Seqirus division would not break even until 2018, some analysts were surprised by the magnitude of the losses and the impact this had on the company's overall operating margins, as highlighted below.
CSL's forecast for around 11% net profit after tax (NPAT) growth in FY17 has also left some investors underwhelmed, with a Bank of America Merrill Lynch analyst pointing out the company's guidance was 15% below market consensus.
So where to from here?
CSL is possibly a victim of its own success as investors have routinely built in high expectations for the company with little margin for error. When the company fails to deliver on these high expectations (as is the case here), it is inevitable that its shares will come under selling pressure.
Even with the recent share price decline, the shares still trade on a price-to-earnings growth (PEG) ratio of more than 2.5. This is still quite expensive by any traditional metric and means CSL will have to justify this valuation with above average earnings growth for many years to come.
Foolish takeaway
I wouldn't be surprised to see CSL's share price fall below $100 per share in the near term if sentiment continues to weaken, but I wouldn't be writing the company off just yet.
It still has some excellent long term growth prospects and some short term share price weakness may provide a valuable buying opportunity for patient investors.
