Published on January 19th, 2022 by Felix Martinez
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 29 consecutive years, which means it is on the Dividend Aristocrats list.
We have compiled a list of all 65 Dividend Aristocrats, along with 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 2021.
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 roughly more than half of the company’s sales, while delivery devices, so far, are responsible for only 4% of sales.
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 brings higher sales. The company has managed to grow its organic sales, which backs out acquisitions, by ~29.8% from January-September 2021.
Source: West Pharmaceutical Services presentation
More recently, it has managed to grow its revenues by double-digits during the last couple of quarters. For example, in the 2021 third quarter, West Pharmaceutical’s revenues rose by 28.9% year over year, to $706.5 million.
Since marginal costs for many healthcare and MedTech industry companies are not overly high, revenue increases usually go hand in hand with some margin expansion.
This was true for West Pharmaceutical Services, which managed to grow its earnings-per-share by an outstanding 111.9% during Q3 on a year-over-year basis.
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 be able to grow its revenues by 28% for the full year of 2021 compared to a prior guidance range of 24% – 25%. This is on an organic basis, which excludes the impact of mergers and acquisitions.
West Pharmaceutical’s growth rate was a little lower than that over the last decade. Factoring in the very encouraging growth in recent quarters, it looks like the company has found a way to improve its growth potential.
We estimate a high-single-digit sales growth rate can be achieved in the long run.
The compelling growth in 2020 can be attributed to West Pharmaceutical Services’ proprietary product segment, which grew by more than 36.9% year over year.
The company’s HVP (high-value products) segment generated double-digit year-over-year growth in 2021. Contract manufacturing also was a segment with above-average growth during the last year.
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 seems achievable.
Source: West Pharmaceutical Services presentation
The above slide shows that the gross margins across West Pharmaceutical Services’ business units differ quite a lot.
Contract manufacturing is a low-margin business, although the company does not have a lot of risks and R&D expenses in that segment.
However, the HVP components business has significantly higher margins. The growth of these segments could easily 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 rate forecast in the 6%-8% range, earnings-per-share could reasonably grow by 8%-10% a year in the long run.
Margin expansion will likely lead to a somewhat improved bottom-line growth rate relative to its sales growth. We forecast an earnings-per-share growth rate of 9% annually.
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.
Among those, West Pharmaceutical Services is the smallest by far. Peers such as Cooper Companies (COOP) or Alcon (ALC) are of a similar size.
West Pharmaceutical Services has a wide range of manufacturing facilities in different countries around the globe. This competitive advantage allows the company to supply to the markets where its products are needed directly while saving on transportation costs.
It also holds more than 300 patents that were rewarded during the last two years alone, which is the result of its investments in R&D when it comes to the company’s proprietary products 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 just 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 that recession is listed below:
- 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 of 2020, West Pharmaceutical Services again performed well.
In 2020, the company grew its earnings-per-share, based on current estimates for the fourth quarter (Q4 results have not been released so far).
This, once again, showcases the strong resilience of the company’s business model during times when the economy is in a recession.
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 by a massive 360%+ over the last five years.
This was, at least partially, the result of a steep increase in its valuation.
West Pharmaceutical Services currently trades for ~47.3 times this year’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.
Up through 2014, West Pharmaceutical Services mostly traded at a high-teens earnings multiple, although the valuation range has expanded since then.
Right now, shares are the most expensive they have ever been, which does not bode well for the company’s future returns.
We believe that shares would be fairly valued at 25 times EPS. As a result, we view the stock as severely overvalued, even when factoring in the forecasted earnings-per-share growth of 9% per year.
With a very low dividend yield of just 0.2%, West Pharmaceutical Services is still expected to generate negative total returns over the coming five years, estimated at -5.5% a year.
This is a very weak projected total return figure and shows the potential danger in buying stocks with extremely elevated valuation multiples. Overall, we do not deem the stock to be a buy at current prices.
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 near-term revenue and earnings growth outlook are compelling.
However, the stock’s valuation is very high, and we believe that shares are massively 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 0.2%. Despite the fact that the company is a Dividend Aristocrat, we rate the stock a sell.
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: