EUR 850.00 For Business Accounts Only

Morningstar | West's Third Quarter Performance Tracks Our Full-Year Expectations; Maintaining $105 FVE

Wide-moat West Pharma reported third-quarter results that fell largely within our expectations. Management reiterated its 2018 outlook for sales and earnings but lowered its expected capital expenditure needs by roughly $10 million. Our forecast was already at the low end of management's prior range, so we don't anticipate any small tweaks to our model to materially change our $105 fair value estimate. While we view the stock as fairly valued near current levels, we think investors should keep an eye on this high-quality business and take advantage of any additional weakness in shares beyond today's decline.

In the firm's proprietary products franchise results came in largely as-expected, posting 6.6% organic growth in the quarter and 120 basis points of gross margin expansion versus the prior year period. Considering that sales to biologic customers were down by a mid-single-digit percentage, largely due to customer inventory de-stocking, we believe the firm is well positioned to accelerate growth into 2019 as these headwinds abate. Growth in West's high-value product portfolio clocked in near a mid-single-digit rate, lower than our forecast that calls for expansion in the low-double-digits for the year, likely in-part due to this transitory impact of order softness out of the biologic customer segment.

In its contract manufacturing business, revenue continued to grow at a 20% pace organically but with a gross profit margin that has lagged year to date as product startup costs and recent capacity expansion initiatives weigh on profitability. While down on a year-over-year basis, the segment's gross margin saw roughly 100 basis points of expansion versus the second quarter, affirming our view that capacity absorption would improve in the second half of 2018. We estimate this segment returning to steady-state gross margin levels near 17%-18%, allowing consolidated gross margin to improve meaningfully over the long run.

Operating expenses were in line with our thinking for the full year, and after backing out $9.1 million in one-time licensing income in the third quarter of 2017, the company showed adjusted operating margin expansion of roughly 110 basis points, consistent with our forecast that calls for modest operating margin improvement for the year.

With a growing cash balance and an unencumbered balance sheet, we think management's capital allocation decision-making will become an increasingly important value-driver for investors. West ended the quarter with a little over $100 million in net cash, up roughly $60 million from the start of the year, after exhausting its share buyback program during the second quarter. We'd look for the board to authorize additional repurchases should the stock fall meaningfully below our fair value estimate, but otherwise we expect management to look toward acquisitions as a primary use of capital.