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I last reviewed West Pharmaceutical (WST) in this April 29 post at which time I disclosed my intent to purchase an additional 50 shares in a 'Core' account within the FFJ Portfolio; I did acquire another 50 shares on April 29 @ ~$357.54 thereby bringing my exposure to 200 shares.
Not much has changed since my April 29 post. However, I purchased an additional 100 shares @ ~$345.56 on May 20 after listening to WST's presentation at BofA's Health Care Conference 2024.
Capital Expenditures
The nature of WST's business is that it must be ahead of the curve; it often takes months/years in order to be prepared to accommodate its clients' future needs. If, for example, WST determines that it merely needs to make equipment changes, the lead time is 12 - 24 months. If it needs to build or modify facilities, the lead time is typically more than 2 years.
WST's CAPEX in FY2014 - FY2023 (in millions of $) was 112, 132, 170, 131, 105, 126, 174, 253, 285, and 362. In Q1 2024, CAPEX was $90.6 million which was $8.5 million higher than Q1 2023. On an annualized basis, FY2024 CAPEX will likely be ~$360.
Once the facilities currently under construction become operational in FY2025, annual CAPEX should return to pre-COVID levels which were ~6% - ~8% of annual revenue. In contrast CAPEX, in FY2021 - FY2023 were ~9%, ~10%, and ~12.3% of annual revenue; this CAPEX increase has been driven by growth initiatives and future demand.
Capital Allocation Priorities
WST's capital allocation priorities are:
- CAPEX;
- share buybacks to maintain share count; and
- mergers and acquisitions is specific segments of business.
Dividend distributions are a very low priority. Management deems the retention of funds in the company to be a superior method by which to generate attractive long-term total shareholder returns.
European Union GMP Annex 1 Regulation
Details of how WST is prepared for the EU GMP Annex 1 regulation is found here.
The EU GMP Annex 1 are guidelines for good manufacturing practices of sterile medicinal products for human and veterinary use. The regulations provide specific requirements for the manufacture of sterile medicinal products, including principles for cleanroom and clean zone design, personnel experience/qualification, and monitoring of manufacturing environments. The objective is to ensure product quality and potency, as well as patient safety, by minimizing risks of microbial, particulate and endotoxin/pyrogen contamination through manufacturing and environmental controls.
WST has witnessed a marked increase in the number of customers looking at their processes since these new regulations have raised the bar for quality.
Why WST Is The Preferred Partner
Product and service quality are the top priority.
Secondly, customers need to know that their vendor of choice has the capacity to provide them with the right products on a timely basis. Due to the fragile supply chain, many customers loaded up on inventory during COVID. In 2023 and YTD 2024, customers have been 'destocking'. This has led to softness in WST's growth.
WST communicates extensively with its customers and all indications are that its customers' inventory levels should return to pre-COVID levels by mid/late 2024.
Valuation
Please refer to my April 29 post for a review of WST's historical valuation.
At the time of my last review, shares were trading at ~$360.50. WST's forward-adjusted diluted PE levels using the current broker estimates were:
- FY2024 - 9 brokers - mean of $7.73 and low/high of $7.63 - $8.13. Using the mean estimate, the forward-adjusted diluted PE is ~46.6.
- FY2025 - 9 brokers - mean of $9.04 and low/high of $8.31 - $9.50. Using the mean estimate, the forward-adjusted diluted PE is ~40.
- FY2026 - 5 brokers - mean of $10.02 and low/high of $9.38 - $10.75. Using the mean estimate, the forward-adjusted diluted PE is ~36.
I also stated:
I think WST's FY2024 FCF might fall short of the $0.415B generated in FY2023. If it generates $0.39B and the diluted weighted average outstanding shares amount to ~74.5 million, WST should generate FCF/share of ~$5.23. Using the current ~$360.50 share price, I estimate a ~69 P/FCF in FY2024.
WST is spending a considerable amount on CAPEX to fuel its growth. Once the current projects are completed, we should see stronger OCF and FCF results because its annual maintenance CAPEX is closer to $130 million versus the ~$300 million it has been spending in recent years. I, therefore, think that WST's annual FCF could exceed $0.5B within the next couple of fiscal years. If this happens, debt repayment coupled with share buybacks could result in a significant improvement in the current very high P/FCF ratio. Should this happen, we could see a significant uptick in WST's share price.
I just acquired additional shares at ~$345.56 and WST's forward-adjusted diluted PE levels using the current broker estimates are:
- FY2024 - 8 brokers - mean of $7.76 and low/high of $7.63 - $8.13. Using the mean estimate, the forward-adjusted diluted PE is ~44.5.
- FY2025 - 8 brokers - mean of $9.08 and low/high of $8.31 - $9.50. Using the mean estimate, the forward-adjusted diluted PE is ~38.1.
- FY2026 - 4 brokers - mean of $10.05 and low/high of $9.38 - $10.75. Using the mean estimate, the forward-adjusted diluted PE is ~34.4.
At the time of my prior post, I estimated that WST would generate FCF/share of ~$5.23. Using my recent ~$345.56 purchase price, I estimate a ~66.1 P/FCF in FY2024.
West Pharmaceutical - Final Thoughts
WST is the global market leader in primary packaging and delivery components for injectable therapeutics. Primary packaging has direct contact with the drug product, and therefore, it must be manufactured to ensure stability, purity, and sterility of the drug product in accordance with strict regulatory standards. The mission-critical nature of these components means it is of utmost importance for customers to trust the quality of manufacturing and design.
Given the quality of WST's products and services and high switching costs, WST typically maintains a client relationship for many, many years. WST's pharmaceutical industry customers focus very heavily on quality standards and switching from WST to a new vendor occurs infrequently which helps reduce volatility in WST's annual results.
WST's heavy CAPEX investment in recent years has dampened its short-term results. However, investments made today lead to rewards a few years into the future.
WST's results have also been adversely affected by inventory 'destocking' and adverse product mix. This 'destocking', however, is almost done and WST's management has reiterated its guidance of 2% - 3% top-line growth with an acceleration expected in the second half of the year with strong results in Q4 2024. This message is similar to that of other companies in the life sciences sector with adjacent business lines.
As noted in my prior post, I expect WST's FCF to improve and its debt level to be lower come FY2025.
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.
