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How times have changed after my November 25, 2022, Buy Out Of Favour West Pharmaceutical post! In that post, I noted that West Pharmaceutical's (WST) short-term headwinds had led to its valuation retracing to a reasonable level and that I had initiated a 100-share position @ ~$225/share in one of the 'Core' accounts within the FFJ Portfolio.
Fast forward to February 16, 2023. WST has released its Q4 and FY2022 results and FY2023 financial guidance and the share price has risen to ~$320.
WST is an ideal example of how relying solely on a company's stock price to make investment decisions is foolish. Looking at WST's market capitalization, calculated by multiplying the price of a stock by its total number of outstanding shares, WST's market capitalization in late November was ~$16.92B. Its current market capitalization is ~$23.67B for a change of ~$6.75B in 2.5 months (the weighted average diluted shares outstanding in Q3 and Q4 2022 are not materially different).
Despite this dramatic change in such a short timeframe, nothing about WST has fundamentally changed. This supports Ben Graham's and Warren Buffett's notion that 'in the short run, the market is a voting machine but in the long run, it is a weighing machine'.
Let's quickly review why I feel WST's valuation is unattractive.
Business Overview
Refer to my previous post for a Business Overview.
Financials
Q4 and FY2022 Results
Please refer to WST's Q4 2022 Earnings Release and Earnings Presentation.
On February 17, 2022, WST released its Q4 and FY2021 results. FY2022 guidance was for:
- net sales of $3.05B - $3.07B;
- adjusted diluted EPS of $9.20 - $9.35; and
- CAPEX of $0.380B.
However, WST lowered its FY2022 net sales and adjusted diluted EPS guidance every quarter in FY2022!
The final revision provided when WST released its Q3 and YTD results called for:
- net sales of $2.83B - $2.84B;
- adjusted diluted EPS of $8.15 - $8.20; and
- CAPEX of $0.3B - $0.32B
WST has now reported FY2022 net sales of ~$2.887B (~7.7% organic sales growth), diluted EPS of $7.73, adjusted diluted EPS of $8.58, and CAPEX of ~$0.285B.
While WST repeatedly lowered its guidance last year, we need to keep in mind that it faced a rapidly shifting pandemic landscape. At the beginning of FY2022, WST expected COVID-19 volume growth. A decline in demand and orders, however, resulted in a 15% decline in pandemic-related sales.
Excluding COVID-19, WST's base organic sales growth was low double-digit, with mid-teens growth in proprietary products. Driving this base growth was the demand for high-value product offerings for both legacy as well as recently launched drugs.
In Q4 2022, WST reported a ~37% consolidated gross profit margin versus ~41.1% in Q4 2021. Proprietary Products' Q4 gross profit margin of 41.6% was 470 bps lower than the margin achieved in Q4 2021. The key drivers for the decline in Proprietary Products' gross profit margin were an unfavourable mix from a reduction in sales related to the COVID-19 vaccine and continued inflationary pressures on plant costs, including raw materials, labour and overheads. These headwinds were partially offset by sales price increases.
Contract Manufacturing's Q4 gross profit margin of 15.4% was 110 bps below the margin achieved in Q4 2021. The decrease is largely attributed to the mix of products sold.
FY2023 Guidance
WST's FY2023 financial guidance is for:
- net sales of $2.935B - $2.960B;
- adjusted-diluted EPS of $7.25 - $7.40; and
- CAPEX of ~$0.35B.
Expectations are for FY2023 overall organic sales growth of ~3% - ~4%. This includes a $0.303B YoY decline in pandemic-related sales ($0.388B in FY2022 to $0.085B in FY2023). Excluding this impact, management expects mid-teens overall base organic sales growth with proprietary products growth in the high teens and high single-digit growth in contract manufacturing.
In FY2019, WST posted a 16.1% operating margin. In 2023, WST expects an operating margin of 23% - 24%, which is an increase of ~800 basis points over 4 years.
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.
Credit Ratings
The FY2022 Form 10-K is not yet available, and therefore, I reference Note 8 - Debt in WST's Q3 2022 Form 10-Q (page 12 of 46) wherein we see details of the company's various credit facilities.
No rating agency rates WST's debt. However, WST's cash flow and balance sheet metrics reflect a prudent use of debt.
The same metrics WST provided when it released Q3 2022 results are provided below for comparison.
Dividend and Dividend Yield
Maintaining the dividend history on WST's website does not appear to be a priority; the last recorded quarterly dividend is that which was paid on August 4, 2021. Instead, refer here for WST's dividend history.
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 when I wrote my post, the dividend yield was ~0.34%.
WST will likely distribute 2 more $0.19 quarterly dividends. If history is any indication of what to expect, a dividend increase of $0.01 will likely be declared in late October. Investors can very likely expect 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 is ~0.24%.
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.
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 total drops to 75.6 in the 3 months ended December 31, 2022.
Stock Splits
WST initiated a 2-for-1 stock split in September 2013.
Valuation
WST's FY2012 - FY2021 diluted PE levels are 23.80, 31.65, 32.46, 47.05, 45.85, 39.47, 47.82, 49.29, 68.60, and 58.12.
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.
Management's FY2023 adjusted-diluted EPS guidance is $7.25 - $7.40. With shares trading at ~$320, the forward adjusted diluted PE range is ~43.2 - ~44.1.
The forward-adjusted diluted PE levels using the current broker estimates are:
- 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.
Adjustments to broker estimates are likely over the next several days. However, I do not envision a material change in WST's forward valuation.
I am reluctant to use FY2024 and FY2025 estimates because much can change over the next 2 - 3 years. Furthermore, only 3 brokers have provided estimates for FY2025.
Final Thoughts
As FY2022 progressed, WST increasingly fell out of favour with investors because guidance continued to be lowered quarterly. By the time I wrote my November 25 post, I think investors had sufficiently soured on WST that shares had finally become slightly undervalued.
In early January, however, WST's share price experienced a fairly steady uptrend culminating in a ~$40.50 share price surge the day WST released Q4 and FY2022 results and FY2023 guidance (February 16, 2023). I now think WST's valuation is unattractive.
If we assign a generous ~32 forward-adjusted diluted PE and use the upper end of management's $7.25 - $7.40 FY2023 adjusted-diluted EPS guidance, a share price below the mid-$230s would place WST's shares at an attractive 'buy' level.
I continue to like WST as a long-term investment. Given its current valuation, however, I am not 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.
