The health care industry has several strong tailwinds, especially among companies active in international markets. Wealth is increasing in most of the world, and that means increasing demand for health services.
In North America, an aging population and more patients with chronic diseases is driving both general health care and the medical devices industry.
In a profile of the medical devices industry, Fortune Business Insights reported, “The global medical devices market is projected to grow from $495.46 billion in 2022 to $718.92 billion by 2029 at a CAGR of 5.5% in forecast period, 2022-2029.”
West Pharmaceutical Services (WST, Financial) has been capitalizing well on that growth so far, and I believe it appears ready to seize on future growth; here's why.
About West Pharmaceutical Services
Founded 100 years ago in 1923 by Herman O. West and J.R. Wike, West Pharmaceutical calls itself “a leading global manufacturer in the design and production of technologically advanced, high-quality, integrated containment and delivery systems for injectable medicines.”
The company develops and manufactures four types of products: stoppers and seals for injectable packaging systems, syringe and cartridge components, self-injection systems and containment and delivery systems. It also provides custom manufacturing and analytical services. Reporting is done through two segments: Proprietary Products and Contract-Manufactured Products.
West Pharmaceutical has an international business, with roughly 55% of its sales made in non-USD currencies. That means the company is exposed to losses or gains from currency fluctuations. In the third quarter, this led to a reduction in Proprietary Products net sales growth of 720 basis points. It also decreased Contract-Manufactured’s net sales growth of 630 basis points.
Competition
Competition varies by segment. For Proprietary Products, competition is based mainly on product design and performance, quality, regulatory and scientific expertise. Total cost is an issue, but not the most important one.
On the other hand, West’s Contract-Manufactured Products division faces “very competitive markets." It noted in its annual filing, “Given the cost pressures they face, many of our customers look to reduce costs by sourcing from low-cost locations.”
It claims to have competitive advantages that keep it in the game. For Proprietary Products, these include its reputation for quality and reliability, knowledge of regulatory requirements and proprietary technology; in 2021, it received over 200 patents worldwide. For Contract-Manufactured, it uses new technologies that include high-speed automated assembly and more.
Here's how the stock price growth compares West Pharmaceutical with peers ResMed Inc. (RMD, Financial) and Baxter International Inc. (BAX, Financial):
Total annual returns over the past five years for West Pharmaceutical were as follows:
- 2023 year-to-date: 15.46%
- 2022: -49.17%
- 2021: 64.87%
- 2020: 88.63%
- 2019: 52.51%
- 2018: -0.07%
Fundamentals
West receives a very high mark for fundamentals with a GF Score of 92 out of 100:
The high GuruFocus financial strength ranking of 9 out of 10 is based on factors such as the interest coverage ratio of 85.78, which reflects good ability to manage the small amount of debt. The debt to revenue ratio is also solid becauses trailing 12-month revenue is $2.909 billion, while short- and long-term debt add up to only $211 million. The Altman Z-Score is also quite high at 17.39 (anything above 3.0 is considered safe).
The profitability gets a 9 out of 10 ranking based on factors such as the operating margin of 27.13%, which is industry-leading and higher than almost 90% of companies in the medical devices and instruments industry.
The growth rank is also 9 out of 10, thanks to its three- and five-year revenue growth rates, its five-year Ebitda growth rate and the predictability of five-year revenue growth. As this revenue chart shows, growth has been consistent and rapid:
West Pharmaceutical is a growth company with a low dividend. The yield of 0.27% is among the worst in the industry, but I think this is fine as the company is focused on growth. The company has repurchased shares; in 2021, that amounted to 471,000 shares at a cost of $137.1 million. During the first nine months of 2022, it bought back 563,334 shares for $202.9 million.
Valuation
Despite its strong fundamentals, West Pharmaceutical’s shares are undervalued in my opinion. It seems the GF Value chart agrees:
The share price has been a victim of the general market slump. The GF Value chart now shows a margin of safety of 47.05%. The discounted cash flow calculator gives it a 2.54% margin of safety when I plug in an estimated 10-year growth rate of 19.30%, which I think is convervative given that earnings per share without non-recurring items has sped up in the past five years, to an average growth rate of 33.90% per year. If we expect that 33.90% growth rate to continue, that pushes the fair value estimate up to $725.94 with a 63.49% margin of safety.
Gurus
Eight of the investing legends followed by GuruFocus owned shares of West Pharmaceutical at the end of the third quarter of 2022 according to their 13F reports.
The three biggest stakes were those of Ron Baron (Trades, Portfolio) of Baron Funds (1,159,204 shares), Jim Simons (Trades, Portfolio) of Renaissance Technologies (199,689 shares) and Ken Fisher (Trades, Portfolio) of Fisher Asset Management (100,401 shares).
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Institutional investors owned 79.90% of shares outstanding and insiders owned 3.22%.
Conclusion
In summary, I believe West Pharmaceutical is undervalued, at least for investors willing to jump on a growth stock despite the bear market. The stock has a signficiant margin of safety according to my estimates of its future growth potential as well as the GF Value chart.
