West Pharmaceutical Remains Richly Valued

Following the release of Q1 2023 results, I analyzed West Pharmaceuticals (WST) to determine if I should increase my exposure. I conclude that WST's valuation is too rich in my May 1 post.

On July 27, WST released its Q2 and YTD2023 and revised FY2023 guidance. I now revisit WST to determine if I should increase my exposure.

Business Overview

WST is the global market leader in primary packaging and delivery components for injectable therapeutics; the best source from which to learn about the company is the 2022 Form 10-K.

Primary Packaging is any packing materials that come into direct contact with Pharmaceutical Preparations.

West designs and manufactures drug packaging and delivery products for pharmaceutical companies such as the rubber components that come into physical contact with a drug, such as the cap, stopper, seal, and plungers. The Products and Services and Solutions sections of WST's website show what WST produces.

WST is essentially the leader in a small but profitable and quickly growing market. It maintains a ~70% market share in injectable primary packaging. The remaining 30% is split between Switzerland's Dätwyler (results reported in Swiss Francs: CHF) and AptarGroup (results reported in USD).

Datwyler is not rated by any rating agency. Aptar Group, however, is rated by Fitch (currently assigns a BBB rating) and by Moody's (currently assigns a Baa3 rating). WST, on the other hand, is not rated by a rating agency because it has minimal debt.

Essentially, this industry is an oligopoly with WST often being selected as the vendor of choice because of its reputation for quality and supply chain expertise. It also produces more than 40 billion components per year from several properties located in various regions globally (refer to 'Locations' on the company's website). This significantly reduces the probability of component shortages; many components can be made in a different facility if a particular plant faces challenges.

Financials

Q2 and YTD2023 Results

Please refer to WST's Q2 2023 Earnings Release, Q2 2023 Form 10-Q, and Earnings Presentation.

The explosion in demand for mRNA-based COVID vaccines resulted in a surge in WST's revenue in FY2020 - FY2022; FY2013 - FY2022 revenue (in billions of USD$) is $1.368, $1.421, $1.400, $1.509, $1.599, $1.717, $1.840, $2.147, $2.832, and $2.887.

WST is experiencing a reduction in COVID-19-related sales; FY2023 net sales guidance assumes COVID-19 sales of ~$60 million - the same as prior guidance. In comparison, WST's COVID-19 revenue in Q4 2021 alone was ~$0.124B!

YTD2023 reported net sales are $1.470B and management's FY2023 net sales outlook is $2.970B - $2.995B. Despite the loss of COVID-related sales, WST's base business is performing well, with midteens growth in proprietary products.

WST is expanding its global operations. In May 2023, it inaugurated its 18,000-square-meter Jurong, Singapore advanced manufacturing facility. This facility is equipped with industry-leading coating, pharmaceutical washing, sterilization and automated vision inspection capabilities for elastomers. This new facility is part of WST’s commitment to invest more than $0.35B globally in 2023, with the majority used to expand capacity and meet the growing needs of customers to support sensitive and complex molecules and the changing regulatory environment.

The Q1 2022 and 2023 results are provided below for comparison.

 

FY2023 Guidance

When I reviewed WST in my February 17, 2023 post, FY2023 financial guidance was:

• net sales of $2.935B - $2.960B;
• adjusted-diluted EPS of $7.25 - $7.40; and
• CAPEX of ~$0.35B.

Expectations were for FY2023 overall organic sales growth of ~3% - ~4%. This included a $0.303B YoY decline in pandemic-related sales ($0.388B in FY2022 to $0.085B in FY2023). Excluding this impact, management expected mid-teens overall base organic sales growth with proprietary products growth in the high teens and high single-digit growth in contract manufacturing.

The outlook was amended when WST released its Q1 2023 earnings.

• net sales of $2.965B - $2.990B;
• adjusted-diluted EPS of $7.50 - $7.65; and
• CAPEX of ~$0.35B (no change).

Although WST reported a ~2.27% decline in net sales and a ~14.6% decline in adjusted diluted EPS relative to Q2 2022, management has again increased its FY2023 outlook.

• net sales of $2.970B - $2.995B;
• adjusted-diluted EPS of $7.65 - $7.80; and
• CAPEX of ~$0.35B (no change).

Free Cash Flow (FCF)

In FY2012 - FY2022, WST generated FCF of (in millions of $): 55, 65, 71, 81, 49, 133, 184, 241, 298, 331, and 439. In the first half of FY2023, WST generated $149.8 million of FCF versus $192.4 million in the first half of FY2022.

Credit Ratings

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

I reference Note 8 - Debt in WST's Q2 2023 Form 10-Q (page 12 of 44) wherein we see details of the company's various credit facilities.

Note 10 in WST's FY2022 Form 10-K (page 68 of 108) provides additional information about WST's various credit facilities.

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 the end of Q2 2023, WST complies with all debt covenants.

The same metrics WST provided when it released Q1 2023 and FY2022 results are provided below for comparison.

 

Dividends, Share Repurchases, and Stock Splits

Dividend and Dividend Yield

WST's dividend history currently does not reflect the $0.19 dividend distributed on August 2. This dividend marks the 4th consecutive quarterly dividend at this level.

I continue to anticipate WST will declare a $0.20/share quarterly dividend in October for distribution in November. This $0.01/share increase is consistent with prior dividend increases.

When I wrote my November 25 post, WST was scheduled to distribute its second $0.19/share quarterly dividend in early February. With shares trading at ~$225, the dividend yield was ~0.34%.

At the time of my February 17 post, I expected the next 4 quarterly dividend distributions to total $0.78 (($0.19 x 2) + ($0.20 x 2)). With shares trading at ~$320, the forward dividend yield was ~0.24%.

At the time of my May 1 post, I envisioned the next 4 quarterly dividend distributions would total $0.79 (($0.19 x 1) + ($0.20 x 3)). With shares trading at ~$366, the forward dividend yield was ~0.216%.

Shares now trade at ~$371 and the next 4 quarterly dividend payments will likely total $0.80 ($0.20 x 4) thus resulting in a ~0.215% forward dividend yield.

This low dividend yield is likely to dissuade some investors from investing in the company. Investors, however, should focus on an investment's total potential long-term investment return. The bulk of WST's future total investment return is likely to continue to be predominantly in the form of capital appreciation.

Share Repurchases

WST's weighted average shares outstanding in FY2012 - FY2022 are (in millions of shares) 71.8, 71.4, 72.8, 73.8, 75, 75.8, 75.4, 75.4, 75.8, 76.3, and 75.8. The diluted weighted average shares outstanding in Q2 2023 is 75.4.

In February 2023, WST's Board approved a share repurchase program under which up to $1.0B in shares can be repurchased. This new program will provide for a continuation of WST's share count-neutral strategy, which forms part of the FY2023 financial guidance.

The share repurchase program does not have an expiration date and the number of shares to be repurchased and the timing of such transactions will depend on a variety of factors, including market conditions.

During the 3 months that ended June 30, 2023, WST purchased 492,710 shares under the program for $173.4 million or an average price of $351.82/share. During the 6 months that ended June 30, 2023, WST purchased 676,070 shares under the program for $233.5 million or an average price of $345.33/share.

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.

In FY2020, WST generated $4.57 and $4.76 in diluted EPS and adjusted diluted EPS. The 52-week intra-day low/high was $124.53 in March 2020 and $305 in November 2020. Using this data, WST's diluted PE range was ~27 - ~66.7 and the adjusted diluted PE range was ~26.2 - ~64.

In FY2021, WST generated $8.67 and $8.58 in diluted EPS and adjusted diluted EPS. The 52-week intra-day low/high was $253.86 in March 2021 and $475.35 in September 2021. Using this data, WST's diluted PE range was ~29.3 - ~54.8 and the adjusted diluted PE range was ~29.6 - ~55.4.

At the time of my November post, WST had generated YTD2022 diluted EPS and adjusted diluted EPS are $6.36 and $6.80. Management's FY2022 adjusted diluted EPS guidance was $8.15 - $8.20. Based on the $8.175 mid-point and the current ~$225 share price, the forward adjusted diluted PE was ~27.5. I estimated WST would generate $1.30 in diluted EPS in Q4, thus giving us FY2022 diluted EPS is ~$7.66. Using this and the ~$225 share price, the forward diluted PE was ~29.4.

Few brokers cover WST but using the adjusted earnings estimates that were available, the following were the forward-adjusted diluted PE levels:

• FY2022 - 6 brokers - mean of $8.17 and low/high of $8.15 - $8.20. Using the mean estimate, the forward-adjusted diluted PE is ~27.5.
• FY2023 - 6 brokers - mean of $7.35 and low/high of $6.54 - $8.05. Using the mean estimate, the forward-adjusted diluted PE is ~30.6.
• FY2024 - 3 brokers - mean of $8.72 and low/high of $8.11 - $9.20. Using the mean estimate, the forward-adjusted diluted PE is ~25.8.

WST ended up generating $7.73 and $8.58 in diluted EPS and adjusted diluted EPS in FY2022. The 52-week intra-day low/high was $206.19 in October 2022 and $468.05 in January 2022. Using this data, WST's diluted PE range was ~26.7 - ~60.5 and the adjusted diluted PE range was ~24 - ~54.6.

When I reviewed WST in February 2023, management's FY2023 adjusted-diluted EPS guidance was $7.25 - $7.40. With shares trading at ~$320, the forward adjusted diluted PE range was ~43.2 - ~44.1.

The forward-adjusted diluted PE levels using the current broker estimates were:

• FY2023 - 8 brokers - mean of $7.24 and low/high of $7.10 - $7.33. Using the mean estimate, the forward-adjusted diluted PE is ~44.2.
• FY2024 - 7 brokers - mean of $8.25 and low/high of $7.96 - $8.57. Using the mean estimate, the forward-adjusted diluted PE is ~38.9.
• FY2025 - 3 brokers - mean of $9.18 and low/high of $8.76 - $9.44. Using the mean estimate, the forward-adjusted diluted PE is ~34.9.

At the time of my May 1 post, shares were trading at ~$366 and management's FY2023 adjusted-diluted EPS guidance had been raised to $7.50 - $7.65 resulting in a ~47.8 - ~48.8 forward adjusted diluted PE range.

The forward-adjusted diluted PE levels using the current broker estimates were:

• FY2023 - 8 brokers - mean of $7.67 and low/high of $7.57 - $7.93. Using the mean estimate, the forward-adjusted diluted PE is ~47.7.
• FY2024 - 8 brokers - mean of $8.68 and low/high of $8.36 - $9.34. Using the mean estimate, the forward-adjusted diluted PE is ~42.2.
• FY2025 - 5 brokers - mean of $9.66 and low/high of $9.40 - $10.35. Using the mean estimate, the forward-adjusted diluted PE is ~37.9.

Shares now trade at ~$371 and management's FY2023 adjusted-diluted EPS guidance had been raised to $7.65 - $7.80 resulting in a ~47.7 - ~48.6 forward adjusted diluted PE range.

The forward-adjusted diluted PE levels using the current broker estimates are:

• FY2023 - 8 brokers - mean of $7.85 and low/high of $7.75 - $7.98. Using the mean estimate, the forward-adjusted diluted PE is ~47.3.
• FY2024 - 8 brokers - mean of $8.83 and low/high of $8.45 - $9.34. Using the mean estimate, the forward-adjusted diluted PE is ~42.
• FY2025 - 5 brokers - mean of $9.88 and low/high of $9.40 - $10.33. Using the mean estimate, the forward-adjusted diluted PE is ~37.6.

WST generated $149.8 million of FCF in the first half of FY2023. If it replicates this level of FCF in the second half of the year, we are looking at ~$0.3B. Let's be optimistic it generates $0.4B for the whole fiscal year. The weighted average shares outstanding in Q2 were 75.4 million and will likely remain at a similar level for the whole year. Divide $0.4B by 75.4 million and we get $5.31 in FCF/share. With shares trading at ~$371, we get a Price/FCF value of ~70!

Final Thoughts

As disclosed in my November 25, 2022 post, I initiated a 100-share WST position @ ~$225/share in one of the 'Core' accounts within the FFJ Portfolio. I should have acquired more shares because this was the very rare occasion when WST shares were undervalued. However, we had just closed a real estate purchase and my liquidity was limited. After that share purchase, WST's valuation has generally been unreasonable.

Although WST is a company in which I want to increase my exposure, I can not justify purchasing more shares at the current valuation. I am looking to increase my exposure in companies that are facing short-term headwinds and which appear to have temporarily fallen out of favour. WST is not such a company.

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.