West Pharmaceuticals: Skeptical On Guidance

| About: West Pharmaceutical (WST)

Summary

Reported a Good Q3 despite Currency Headwinds.

2020 Guidance Appears Aggressive.

Has had Difficulties Meeting Guidance in the Past.

West Pharmaceuticals (NYSE:WST) reported a good quarter with core sales down 3.2% year over year but up 5.2% on a constant currency basis. FX continues to be an issue for West as the decline in the Euro relative to the US dollar continues to hurt sales and earnings. Adjusted earnings of $0.44 cents beat estimates by $0.01 despite being hurt by currency to the tune of 13.6%. The company has done reasonably well despite the Euro and indicated on the call the pipeline of new products looks good.

Management provided 2020 guidance numbers of $2.2 billion to $2.4 billion and 19 %to 23% operating margins. While I really like West's niche business, I am skeptical over their ability to achieve guidance as the company continues to push out the $2.2 billion number.

Sales Guidance

For 2020, management is targeting $2.2 billion to $2.4 billion in sales. This requires sales grow more than 55% from the $1.4 billion expected in 2015 just to meet the low end of guidance. If sales are to meet the high end of guidance, they must grow more than 70%.

This requires a compound annual growth rate of about 8% to meet the low end of guidance and nearly 9.5% to meet the high end of guidance. While these numbers appear reasonable, West has only been able to grow sales at around 4-5% from 2006 to the 2015 sales estimate of $1.4 billion. Further, management cautions investors suggesting that sales growth could be lumpy depending on drug approvals or the ramp up of a particular new product.

Margin Guidance

For 2020, management is targeting 19 to 23% operating margins. This compares with significantly lower margins over the past 5 years. While management has steadily improved margins, even a 20% margin would be an impressive improvement over 2014 levels. That said, YTD 2015 margins continue the trend of improvement at nearly 14%.

 

2014

2013

2012

2011

2010

Operating Margins

12.8%

11.90%

10.7%

9.20%

8.20%

Management may also be setting unreasonable expectations for its Pharmaceutical Delivery Systems ((NYSE:PDS)) division. Management is targeting a 50/ 50 split of proprietary vs. contract manufacturing and hoping that margins improve proprietary margins from high 20% range to high 30% range. Despite that target, contract manufacturing was still a key driver of PDS sales growth in 2014.

"whereas with proprietary today we're not that much better. We're probably in the high 20s, low 30s, but that's really volume related, not pushing - not having as much throughput through those plants on a very lumpy, as we said, basis for those products. When we go out further in the plan we see our margins getting into, for those types of products, for the proprietary delivery system products, being in the high 30s."

Of course margin improvement is possible with higher proprietary volumes but we're asking management to do something they've not done before in a sales environment that can be out of their control.

Some Historical Guidance Missteps

My skepticism grows given some of West's previous issues with guidance.

  • In 2012, the company targeted $1.7 to $1.9 billion in 2016 Sales. Current estimates for 2016 are below $1.5 billion and down from nearly $1.7 billion a year ago. In the Q3 call, management appears to suggest much of the sales miss (around $175 million) to currency but that doesn't account for the remainder. The company appears to be having difficulty meeting the low end of guidance.
  • In 2014, the company targeted $2 to $2.2 billion in 2018 sales and high teens operating margins. These sales numbers are now pushed out to the 2020 range and while margins have improved (as shown above) they are not even close to the high-teens suggested by management and will have to jump around 4% to be considered high teens in 2018.
  • They were also targeting $1.77 to $1.89 in EPS in 2014. At this point, the company will not meet the high end of that range in 2015 - guidance is $1.79 to $1.84. They are, however, expected to meet that number in 2016 now.

Where I could be wrong?

A strong Euro relative to the US Dollar would provide a nice tailwind to sales and earnings as FX has been an ongoing headwind. Further, management is expanding capacity to meet demand so future sales growth could in fact be higher than in recent years. On the call, they suggested that some high margin, high value products are running at 100% capacity so this could certainly help both sales and margins once capacity is online. Biologics continue to be a key driver of demand.

As well, despite guidance issues, the stock keeps performing well. I have to respect that there aren't many businesses like West with a niche end market and high barriers to entry. This makes it an attractive takeover target to a traditional packaging firm (like a glass or can manufacturer) looking to diversify into more growth end markets.

Similarly, the balance sheet is in good shape at just above 1x debt to EBITDA. The company should be able to fund capex and could lever up the balance sheet for an acquisition.

Summary

It's hard to argue with the success at West. The barriers to entry are obvious - it could take years for other packaging companies to develop the expertise and relationships to even meaningfully enter the industry. Management has a good pipeline as they continue to expand facilities in North Carolina and Ireland to meet demand, particularly in biologics As a result, the stock price has performed well over time.

However, sales don't seem to be coming in as fast as expected and margins have been slow to expand. And they've had to spend a lot to just keep and grow the existing business - ROIC in 2014 was just 10% (a 5-year high). For 2020, Management appears to have set themselves another high bar to jump over instead a low one they could step over. I'll look for an opportunity to invest when the bar is lower.

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.

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Tagged: , Packaging & Containers, Earnings
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