West Pharmaceutical Expects A Challenging FY2024

I initiated a West Pharmaceutical (WST) position on November 25, 2022 with the purchase of 100 shares @ ~$225 in a 'Core' account within the FFJ Portfolio. I would have acquired more shares but we had just closed the purchase of an additional property which put a dent in my liquidity. By the time I replenished my liquidity, WST's valuation was no longer attractive and I had to place it on my 'Watch List'.

When I subsequently revisited WST in my May 1 post and August 3 post, I concluded that its valuation was too rich for my liking.

On February 15, 2024, WST released its Q4 and FY2023 results and FY2024 outlook. The investment community did not react favorably and the share price plunged from ~$415 to ~$330. After reviewing WST's results and outlook, I acquired another 50 shares @ ~$340 bringing my WST exposure to 150 shares. As I compose this post, the share price has rebounded to ~$362.

Business Overview

A business overview is provided in my August 3 post. I, however, highly recommend referring to the company's website and the most recent Form 10-K; I anticipate the FY2023 Form 10-K will be released within the next few days. Until such time, I encourage you to read Part 1 in the 2022 Form 10-K.

Financials

Q4 and FY2024 Results

Please refer to WST's Q4 Earnings Release and Earnings Presentation that are accessible from the company's website.

The following reflect business and financial highlights from FY2023.

FY2024 Guidance

WST's FY2024 guidance is:

• Consolidated Net Sales: $3B - $3.025B
• Adjusted-Diluted EPS: $7.50 - $7.75

On the Q4 earnings call, management stated that WST is facing several challenges to its growth model thus leading to guidance of 2% - 3% organic sales growth for FY2024. This is ~5% - ~6% lower than its preliminary outlook. This variance is attributed to:

1. Initial expectations were for flat COVID-related sales. Demand, however, continues to decline resulting in a ~1% decrease in organic sales.
2. The timing of HVP device manufacturing capacity coming online, to satisfy customer demand has been pushed out, causing a percentage point of headwind. HPV infection is a viral infection that commonly causes skin or mucous membrane growths (warts). There are more than 100 varieties of human papillomavirus (HPV). Some types cause warts and some can cause different types of cancer although most do not lead to cancer. However, some types of genital HPV can cause cancer of the lower part of the uterus that connects to the vagina (cervix). Other types of cancers, including cancers of the anus, penis, vagina, vulva and back of the throat (oropharyngeal), have been linked to HPV infection. These infections are often transmitted sexually or through other skin-to-skin contact. Vaccines can help protect against the strains of HPV most likely to cause genital warts or cervical cancer.
3. The timing of a customer's upgrade to a higher HVP tier is contributing to a ~1% headwind.
4. There is a more widespread destocking that is causing ~2% - 3% of headwind. This inventory destocking trend has reached WST's segment of the injectable drug value chain within the last couple of months. While WST anticipated some impact from this destocking in 2024, it has been surprised by the magnitude and speed in which customers have changed their forecasts. In several cases, WST's customers have also expressed a similar sentiment at the amount of forecast changes being handed to them.

WST expects the timing of new HVP device capacity and customer-led HVP upgrade and the widespread destocking to have the greatest impact on its Q1 results. There is likely to be some impact on Q2 results but this should be to a lesser degree than in Q1. In the second half of FY2024, WST anticipates better growth that is in line with its long-term growth projections.

This 2024 guidance is supported by the following:

1. WST's February order book for the second half of FY2024 exceeds pre-pandemic levels.
2. Some customers are expected to be able to produce more drugs as the year progresses.
3. The HVP device capacity is expected to improve in the second half of the year as WST implements process modifications that are designed to improve manufacturing throughput.

Excluding further COVID demand reduction, the impact to WST's FY2024 guidance is time related to new capacity and timing of customer upgrades.

The destocking issue is an industry-wide phenomenon and not a change in WST's market share or in patient demand for drug volumes.

On the CAPEX front, WST will be expanding its industry-leading capacity with major HVP expansion projects in Jersey Shore, Pennsylvania and Eschweiler, Germany. It has also started a significant expansion at its Dublin, Ireland facility, which is already dedicated to contracted demand for future injection device manufacturing.

Operating Cash Flow (OCF) and Free Cash Flow (FCF)

In FY2012 - FY2023, WST generated OCF of (in millions of $ approx): 18,3 212, 219, 263, 289, 367, 473, 584, 724, and 777.

In FY2012 - FY2023, WST generated FCF of (in millions of $ approx): 55, 65, 71, 81, 49, 133, 184, 241, 298, 331, 439, and 415.

WST deployed ~$0.362B toward CAPEX in FY2023. The long-term growth prospects remain intact and FY2024 will be another active year of capital investments to increase WST's high-value product manufacturing capacity and/or contract manufacturing capacity; FY2024 CAPEX guidance is ~$0.35B.

Credit Ratings

No rating agency rates WST's debt. However, WST's cash flow and balance sheet metrics reflect a prudent use of debt.

The FY2023 Form 10-K is unavailable as I compose this post. Note 8 - Debt in WST's Q3 2023 Form 10-Q (page 12 of 82), however, provides details of the company's various credit facilities.

At FYE2023, WST had $206.8 million of debt outstanding. This is similar to ~$208 million at the end of Q3. Roughly $53 million is the 3.82% Series B notes due July 5, 2024 and roughly $81.5 million is a 6.37% Term Loan due December 31, 2024. The remaining $73 million is the 4.02% Series C notes due July 5, 2027.

I anticipate the obligations maturing in 2024 will be retired thus leaving WST with virtually no debt (excludes the typical liabilities such as accounts payable, accrued salaries, wages and benefits, income taxes payable, operating lease liabilities). There is also deferred income that is included within other current liabilities and other long-term liabilities. This, however, represents customer prepayments for which WST will provide services at a later date (primarily within the year).

Various financial covenants in WST's debt agreements include the need to maintain established interest coverage ratios and to not exceed established leverage ratios. The agreements also contain other customary covenants, none of which are restrictive to WST's operations. At FYE2023, WST complied with all debt covenants.

Dividends, Share Repurchases, and Stock Splits

Dividend and Dividend Yield

WST does have a dividend history. A WST investment, however, is typically not made for dividend income.  This is a low dividend yielding company and the bulk of WST's total long-term investment return is likely to continued to be derived from capital appreciation.

Share Repurchases

WST's weighted average shares outstanding in FY2012 - FY2023 are (in millions of shares) 71.8, 71.4, 72.8, 73.8, 75, 75.8, 75.4, 75.4, 75.8, 76.3, 75.8, and 75.3. The diluted weighted average shares outstanding in Q4 2023 was ~75.

While WST does repurchase shares, repurchases are generally made for the purpose of maintaining a neutral share count.

Stock Splits

WST initiated a 2-for-1 stock split in September 2013.

Valuation

WST's FY2012 - FY2022 diluted PE levels are 23.80, 31.65, 32.46, 47.05, 45.85, 39.47, 47.82, 49.29, 68.60, 58.12, and 28.53.

I reference my August 3, 2023 post in which I calculated WST valuation at different points in time.

In FY2023, WST generated $7.88 and $8.08 of diluted EPS and adjusted diluted EPS, respectively. With shares trading at ~$362, the diluted PE and adjusted diluted PE levels are ~46 and ~44.8.

It generated ~$414.5 million in FCF and with a weighted average number of diluted shares outstanding in FY2023 of 75.3 million, WST generated ~$5.50 of FCF/share. This gives us a P/FCF of ~65.8.

Management's FY2023 adjusted diluted EPS guidance is $7.50 - $7.75. Using the current ~$362 share price, the forward adjusted diluted PE range is ~46.7 - ~48.3.

The forward-adjusted diluted PE levels using the ~$362 share price and the current broker estimates are:

• FY2024 - 9 brokers - mean of $7.62 and low/high of $7.50 - $7.89. Using the mean estimate, the forward-adjusted diluted PE is ~47.5.
• FY2025 - 9 brokers - mean of $9.03 and low/high of $8.54 - $9.50. Using the mean estimate, the forward-adjusted diluted PE is ~40.
• FY2026 - 5 brokers - mean of $10.12 and low/high of $9.64 - $10.80. Using the mean estimate, the forward-adjusted diluted PE is ~35.8.

I anticipate that WST will generate a similar level of FCF in FY2024 as in FY2023. In addition, WST's share repurchases are for the purpose of maintaining its share count at a relatively constant level. As a result, I expect WST's P/FCF in FY2024 will be similar to the ~65.8 in FY2023.

Having recently purchase additional shares @ ~$340, I acquired shares at a slightly more favorable valuation.

Final Thoughts

WST's shares are pretty much always richly valued with the exception of a brief period in 2022 when I initiated a position.

Prior to the release of Q4 and FY2023 results on February 15 when shares piqued at ~$415, WST was significantly overvalued. I viewed the  share price plunge to ~$330 as a buying opportunity. By the time I had a chance to review WST's results, however, the share price had rebounded to ~$340.

As I compose this post, WST's ~$362 share price has moved it to being moderately overvalued.

WST benefits from very strong intangibles and switching costs and it is is the global market leader in primary packaging and delivery components for injectable therapeutics. This type of packaging has direct contact with the drug product. As a result, all products must be manufactured in accordance with strict regulatory standards. Customers MUST trust the quality of manufacturing and design.

WST maintains a ~70% market share of elastomer components for injectable drugs. The remaining 30% is split between Dätwyler Holding Inc. which is based in Switzerland and AptarGroup, Inc.; both companies report the same headwinds WST faces.

I have no interest in investing in Dätwyler because it is a Swiss based company and I can not easily understand its financial statements. I also have no interest in investing in AptarGroup because its senior domestic unsecured long-term debt is rated Baa3 and BBB- by Moody's and S&P Global. WST, on the other hand, has enough cash and cash equivalents to wipe out 100% of its debt.

As noted in several previous posts, I am looking to invest in great companies that have fallen out of favor with investors because they are experiencing short-term headwinds.

Despite the significant share price pullback following the recent release of Q4 and FY2023 results and FY2024 outlook, WST shares are still somewhat overvalued. Nevertheless, I like WST's long-term outlook and have acquired additional shares even though the valuation is not remotely as attractive as when I initiated a position in November 2022.

I continue to think we are experiencing a period of irrational exuberance. Should we experience a broad market pullback, WST is one of the companies in which I would very seriously consider adding to my exposure.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long WST.

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.