EUR 850.00 For Business Accounts Only

Morningstar | West Pharma Starts 2019 Ahead of Expectations; Raising FVE

Wide-moat West Pharmaceutical Services reported a strong start to its year with organic revenue expanding 11%, led by its high-value product portfolio that expanded nearly 20% on a reported basis, by our math. We'll probably bump up our $100 fair value estimate by a mid-single-digit percentage as we tweak our model to account for this better-than-expected growth. However, with the stock currently trading at over 40 times our 2019 adjusted earnings estimate, we have a hard time strongly recommending the name.

The firm's proprietary product franchise accelerated in the quarter, posting 9.4% organic growth versus rates nearer the midsingle digits last year. A primary driver, in our view, is the return to double-digit growth from the company's biologic customer segment following persistent weakness throughout 2018. We expected this channel to accelerate in 2019, underpinning our forecast for roughly 9% reported growth for the firm's high-value product category. This product portfolio accounted for nearly 60% of total proprietary segment revenue in the quarter, up from roughly 54% during 2018. The shift from standard to high-value products and services is critical to the West thesis and accounted for the bulk of the 180-basis-point expansion in proprietary product gross margin. We anticipate a similar level of improvement throughout the rest of the year and project 150 basis points, on average, of annual segment margin expansion over our five-year forecast period.

Contract manufacturing also had a standout quarter, with organic growth in the high teens. We expect this to moderate throughout the course of the year, given tough comparisons over the next three quarters. That said, we believe segment margin is likely to improve with increased utilization of recently expanded manufacturing capacity. Mix should also contribute to both growth and margin over the long run as legacy consumer products are de-emphasized relative to healthcare-related opportunities.

Management already exhausted the 800,000-share repurchase authorization announced in late February at an average price of $103.89 per share. With the buyback done at prices roughly in line with our fair value estimate, we're indifferent about the decision. However as we think about capital allocation, unless another program is authorized, it looks as if 2019 is poised to be another year of seeing cash build on the balance sheet. The board raised the firm's per-share dividend by roughly 10% for the first-quarter payout, but cash flow will outstrip requirements for dividends, capital expenditures, and the completed buyback, by our estimate. The previously announced acquisition of the firm's distributor in South Korea closed in the quarter, but this looks to be a relatively small outlay.