Updated on January 30th, 2023 by Jonathan Weber
We provide an individual analysis of all Dividend Aristocrats each year. The next up in our annual Dividend Aristocrats In Focus series is West Pharmaceutical Services (WST).
The shares have performed extremely well in recent years. This performance was based on strong earnings growth and an expanding valuation multiple.
West Pharmaceutical has also raised its dividend for 30 consecutive years, which means it is on the Dividend Aristocrats list. (https://www.suredividend.com/dividend-aristocrats-list/)
We have compiled a list of all 65 Dividend Aristocrats and important financial metrics such as price-to-earnings ratios and dividend yields. You can download the full list by clicking on the link below:
This article will discuss West Pharmaceutical’s business model, growth potential, competitive advantages, and whether we view the stock as a buy for 2023.
Business Overview
West Pharmaceutical Services is a healthcare company. It manufactures and sells medical packaging and medical components. It is also a contract manufacturer for other MedTech companies.
Products include automatic medication delivery systems and medicine injection solutions, among others.
Source: West Pharmaceutical Services presentation
Sales are mostly generated in the US and the MENA region. This is not a big surprise, as healthcare expenditures on a per-capita basis are among the highest in the US and Europe. High-Value Product Components make up more than half of the company’s sales, while delivery devices contribute a much smaller portion of West Pharmaceutical’s revenue.
West Pharmaceutical Services benefits from long-term growth in the healthcare industry. As an aging population requires more and more medical care, this leads to higher drug sales. In turn, this benefits West Pharmaceutical, as this allows for considerable sales growth over time.
The company has managed to grow its organic sales, which backs out acquisitions, by close to 30% in 2021, but 2022 was a weaker year in terms of sales growth. This was due to the COVID impact in 2021. Adjusted for that, organic sales growth remained strong throughout the last couple of years, and well north of the company’s 7%-9% long-term goal:
Source: West Pharmaceutical Services presentation
During the most recent quarter, Q3 2022, West Pharmaceutical Services grew its revenue by 4% on an organic basis, to $690 million. The company’s guidance for 2022 (Q4 results have not yet been reported) was set at $2.83 billion to $2.84 billion, implying a little more than $700 million in revenue per quarter. At the same time, the company guided for earnings-per-share of $8.18, down slightly versus 2021 but up massively versus pre-pandemic levels.
Growth Prospects
Healthcare stocks will benefit from ongoing macro trends such as an aging population and increasing numbers of new therapies that seek to treat all kinds of ailments. As a result, West Pharmaceutical Services will likely continue to see ongoing growth from its core businesses, manufacturing, and parts production.
Management believes that West Pharmaceutical Services will report relatively flat revenues for 2022, but that is due to very tough comparison with the previous year’s outstanding revenue growth.
West Pharmaceutical’s growth rate was solid but not spectacular over the last decade. Prior to 2021, there was a trend of improving growth, suggesting that West Pharmaceutical Services’ growth investments increasingly paid off. In 2021, sales soared due to the COVID impact, which will likely not replicate in the future.
Going forward, West Pharmaceutical Services’ proprietary product portfolio could help the company in improving its organic sales growth rate in the long run. We thus believe that management’s guidance of a 6%-8% annual sales growth rate does not look overly bullish. We believe that a high single digit sales growth rate can be achieved in the long run.
West Pharmaceutical Services’ High Value Products components business has above-average margins. The growth of this segment could lift company-wide margins over the coming years. As such, it would not be a surprise to see net profits grow at a somewhat steeper rate than revenue. With a sales growth of 6%-8% per year in the long run, earnings-per-share could reasonably grow by 8%-10% a year in the future, which is why we are forecasting a 9% annual earnings-per-share increase going forward.
Competitive Advantages & Recession Performance
West Pharmaceutical Services is not among the largest healthcare companies in the world. However, its main competitors are not companies such as Johnson & Johnson (JNJ), but rather other parts producers and contract manufacturers. Peers such as Cooper Companies (COOP) or Alcon (ALC) are of a similar size.
West Pharmaceutical Services has a range of manufacturing facilities in different countries around the globe. This competitive advantage allows the company to supply directly to the markets where its products are needed while saving on transportation costs.
It also holds several hundred patents that were rewarded over the last couple of years alone, which is the result of its investments in R&D when it comes to proprietary product offerings. In that regard, West Pharmaceutical Services’ investments could pay off in the long run, through an above-average growth rate and a product portfolio that is well-protected against potential new market entrants.
Healthcare is a recession-resilient industry, as demand for medication and treatments does not depend highly on the strength of the economy. During the Great Recession, West Pharmaceutical Services’ earnings-per-share declined by less than 15% peak-to-trough.
This is an attractive performance, both on an absolute basis as well as relative to the big profit declines that were experienced by many other companies with more vulnerable businesses.
WST’s performance during the Great Recession looked like this:
- 2008 earnings-per-share: $1.19
- 2009 earnings-per-share: $1.06 (11% decrease)
- 2010 earnings-per-share: $1.05 (0.9% decrease)
- 2011 earnings-per-share: $1.17 (11% increase)
During the coronavirus pandemic, West Pharmaceutical Services again performed well. In 2020, the company grew its earnings-per-share, and earnings-per-share soared in 2021. This, once again, showcases the strong resilience of the company’s business model during times when the economy is in a recession.
The company’s resilience during economic downturns makes West Pharmaceutical Services an attractive choice for risk-averse investors, at least on a fundamental basis.
Valuation & Expected Returns
In the recent past, West Pharmaceutical Services has delivered highly attractive returns, as its shares rose massively (~170%) over the last five years. This was mostly driven by strong earnings growth in that time frame.
West Pharmaceutical Services currently trades for ~35 times 2023’s expected earnings-per-share, based on current consensus estimates. That is a quite high valuation, both in absolute terms, as well as relative to how the company was valued in the past, looking back a decade and more.
Shares were even more expensive than they are today in 2020 and 2021, but they still seem too expensive right now. We believe that shares would be fairly valued at 25 times EPS. As a result, we view the stock as overvalued, even when factoring in the forecasted earnings-per-share growth of 9% per year.
With a very low dividend yield of just 0.3%, West Pharmaceutical Services is expected to generate rather unattractive total returns over the coming five years: Factoring in a 6.5% multiple compression headwind, the forecasted earnings-per-share growth, and the dividend yield, our estimate is that West Pharmaceutical Services will generate total returns in the 3% range.
This is a rather weak projected total return figure and shows the potential danger of buying stocks with elevated valuation multiples.
Final Thoughts
West Pharmaceutical Services is a strong company on a fundamental basis. The business is recession-resistant, the company benefits from macro growth tailwinds, and the company’s longer-term revenue and earnings growth potential are compelling.
However, the stock’s valuation is very high, and we believe that shares are substantially overvalued at current levels. We thus think that West Pharmaceutical Services is a company that is not suitable for investment at current valuation levels, even though we like many of the underlying properties of the company.
The very high share price also is the reason why West Pharmaceutical Services’ dividend yield is very low, at just 0.3%. Despite the fact that the company is a Dividend Aristocrat, we rate the stock a sell at current prices.
If you are interested in finding high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:
- The Dividend Achievers List: a group of stocks with 10+ years of consecutive dividend increases.
- The Dividend Kings List: considered to be the best-of-the-best among dividend growth stocks, the Dividend Kings are a group of exceptional dividend stocks with 50+ years of consecutive dividend increases.
- The Blue Chip Stocks List: contains stocks on either the Dividend Achievers, Dividend Aristocrats, or Dividend Kings list.
- The Monthly Dividend Stocks List: contains stocks that pay dividends each month, for 12 payments per year.
- The High Dividend Stocks List: high dividend stocks are suited for investors that need income now (as opposed to growth later) by listing stocks with 5%+ dividend yields.
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly: