West Pharmaceutical Services: Packaging For The Vaccine (NYSE:WST)


The process for selecting the best high-quality packaging components for use with injectable medicines, including vaccines, is a complex one driven by years of science, which West Pharmaceutical Services has pioneered. – Eric Green

As mentioned in the ‘Leaders-Laggard’ segment of this week’s edition of The Lead-Lag Report, vaccine-related news was not particularly encouraging. This consequently impacted the healthcare sector, which has now seemingly taken up the baton of being the chief proxy of vaccine-related news, even though some of these healthcare-based stocks are unlikely to benefit from any developments regarding a vaccine. Conversely, my article today focuses on West Pharmaceutical Services (WST), a company whose operations have benefitted from the onset of COVID-19 and will likely benefit even more, as the quest for a vaccine gathers pace.

WST manufactures packaging components and delivery systems for injectable drug and healthcare products. Customers include leading global companies from the biologic, generic, pharmaceutical, and diagnostic space. The company reports under two segments – 1) Proprietary products – Here, it offers discretionary packaging solutions, containment, and drug delivery products and analytical lab services. 2) Contract-manufacturing – Here, WST focuses on designing, manufacturing and automating customized and complex devices primarily for pharma, diagnostic and medical device customers.

Here are some of the reasons why I like this company.

COVID-19 impact

WST is one of the large players in the healthcare packaging space, and plays a crucial role in helping its customers bring new drugs and treatments to the end-markets. Do note that even before COVID-19, this is a company that was coasting along at a fine pace, with the order backlog in FY19 growing by 44% annually, to hit $588m. WST has years of experience under its belt, having been around since 1927, and the critical nature of packaging components and the urgency behind vaccine-development for COVID-19 have brought even more attention to this company. Since Q1, WST has seen a high adoption for its stopper products – FluroTec and NovaPure.

WST is well-placed to deal with the surge in operations as various vaccine development initiatives move from clinical trials to a potential commercial launch. Q2 results were impressive, with the company reporting 14% organic sales growth, with COVID-19 related business boosting sales volumes by c.$19m. In addition to that, such has been the demand for its products that it recently scaled up its FY revenue guidance by c.4% from the previous range of $1.95-1.97bn to $2.035-2.055bn. As part of this guidance, the company expects to see a further $60m accretion to revenue on account of COVID-19 related business. WST is preparing for a volume surge in its key products such as FluroTec and NovaPure and has also upped its CAPEX guidance by c.30% from c.$135m to c.$175m.

Balance sheet and cash flow strength

WST has the financial resources to comfortably ramp up its CAPEX spend without depending on external resources. Over the years, it has managed to turn around a net debt position to a net cash position; 10 years ago, in Dec-2009, the company had net debt to the tune of $253.7m. This has fallen almost every year since, and at the end of last year, the company had a net cash position of $109.8m (the H1-20 net cash position was $116.8m).

Source: Prepared by the author using data from Seeking Alpha

During this same period, buoyed by consistent progression at the operating level, the company has also been able to boost its free cash flow (FCF), which has grown at 15% CAGR. In H1, its operating cash flow grew by 34% annually, even as it saw an improvement in its Days Sales Outstanding (DSOs) and Days Payable Outstanding (DPOs).

Source: Prepared by the author using data from Seeking Alpha

Consistent dividend growth

Given the performance of the WST share, which is close to all-time highs, the current dividend yield at 0.23% feels like a pittance, but do consider that this is a company that has been very committed to sharing its bounties with its shareholders. Dividends have been increased every single year for the last 27 years! Over the last five years, dividends have grown at a CAGR of more than 8%.

Source: Seeking Alpha

If you do decide to pursue this stock, you should also be aware of certain risks such as –

Recent dollar appreciation

Late in August, I questioned if investors may have been a bit too pessimistic on the dollar. The dollar index has since rebounded by c.2-2.5%. In this week’s Lead-Lag Report, I’ve suggested that the greenback’s recent movement is confirming ongoing strength in the treasury market and utility stocks (which broadly reflects risk-off sentiment). If risk-off sentiment continues, we could see the dollar continue to appreciate. This may serve as a meaningful FX headwind in the coming quarters as about 50-55% of the WST’s annual sales come from outside the U.S.

Aluminum prices

Source: LME

In Q2, WST put on an impressive show on the gross profit (GP) front. GP rose by 24% annually with margins of 37%, expanding by an impressive 340bps. In Q3, whilst WST’s sales volumes and pricing are expected to be resilient, there could be a spike in COGS, as aluminum prices have really picked up in Q3. From July to August, prices rose by 14%. Aluminum is one of the top 3 raw materials that WST uses for the manufacturing of its products.

Contract-manufacturing segment in H2

In H1, the contract-manufacturing segment was rather resilient, with H1 sales in organic terms growing by 17% on an annual basis and gross profit growing by 36%. The GP margin too increased by 2.6%. Yet, it may likely be challenging to replicate the same momentum in H2 as the comparatives from last year are much higher.

Valuations and conclusion

Source: YCharts

Over the years, WST has demonstrated consistent growth across its key financial metrics. Since 2015, revenue, operating profit, and net income have grown every year, at CAGRs of 7.1%, 14%, and 27%, respectively. WST also has an admirable balance sheet and has been consistent in distributing higher dividends every year. The order back-log (including non-COVID-related business) looks sturdy, and the company’s packaging products & services are in great demand as vaccine-development related to COVID-19 reaches its final stages. All this has resulted in the stock trading close to all-time highs, at an exorbitant forward P/E multiple of 65x! This represents a premium of c.48% to the stock’s average 5-year forward P/E multiple of 44x. Regardless of the company’s attractive business prospects, I remain wary of pursuing a stock at this valuation multiple. Besides, in the coming quarters, we could also see a few headwinds such as the dollar performance, high base effect for contract manufacturing and higher aluminum prices. Wait for a better entry point. Neutral for now.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This writing is for informational purposes only and Lead-Lag Publishing, LLC undertakes no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Lead-Lag Publishing, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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