One of Wall Street's biggest winners of the day is West Pharmaceutical Services, a medical instruments & supplies company whose shares have climbed 21.1% to a price of $346.88 -- near its average analyst target price of $343.46.
The average analyst rating for the stock is buy. WST may have outstripped the S&P 500 index by 21.0% so far today, but it has lagged behind the index by 52.6% over the last year, returning -12.5%.
West Pharmaceutical Services, Inc. designs, manufactures, and sells containment and delivery systems for injectable drugs and healthcare products in the Americas, Europe, the Middle East, Africa, and the Asia Pacific. The company is part of the healthcare sector. Healthcare companies work in incredibly complex markets, and their valuations can change in an instant based on a denied drug approval, a research and development breakthrough at a competitor, or a new government regulation. In the longer term, healthcare companies are affected by factors as varied as demographics and epidemiology. Investors who want to understand the healthcare market should be prepared for deep dives into a wide range of topics.
West Pharmaceutical Services's trailing 12 month P/E ratio is 49.4, based on its trailing EPS of $7.02. The company has a forward P/E ratio of 44.6 according to its forward EPS of $7.78 -- which is an estimate of what its earnings will look like in the next quarter.
The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead). As of the third quarter of 2024, the health care sector has an average P/E ratio of 26.07, and the average for the S&P 500 is 29.3.
WST’s price to earnings ratio can be divided by its projected five-year growth rate, to give us the price to earnings, or PEG ratio. This allows us to put its earnings valuation in the context of its growth expectations which is useful because companies with low P/E ratios often have low growth, which means they actually do not present an attractive value.
When we perform the calculation for West Pharmaceutical Services, we obtain a PEG ratio of 40.73, which indicates that the company is overvalued compared to its growth prospects. The weakness with PEG ratios is that they rely on expected growth estimates, which of course may not turn out as expected.
To gauge the health of West Pharmaceutical Services's underlying business, let's look at gross profit margins, which are the company's revenue minus the cost of goods only. Analyzing gross profit margins gives us a good picture of the company's pure profit potential and pricing power in its market, unclouded by other factors. As such, it can provide insights into the company's competitive advantages -- or lack thereof.
WST's gross profit margins have averaged 36.7% over the last four years. While not particularly impressive, this level of margin at least indicates that the basic business model of the company is consistently profitable. These margins have slightly increased over the last four years, with an average growth rate of 3.2%. West Pharmaceutical Services's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to the company's operating cash flows minus its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:
| Date Reported | Cash Flow from Operations ($ k) | Capital expenditures ($ k) | Free Cash Flow ($ k) | YoY Growth (%) |
|---|---|---|---|---|
| 2023 | 776,500 | 362,000 | 414,500 | -5.67 |
| 2022 | 724,000 | 284,600 | 439,400 | 32.91 |
| 2021 | 584,000 | 253,400 | 330,600 | 10.9 |
| 2020 | 472,500 | 174,400 | 298,100 | 23.8 |
| 2019 | 367,200 | 126,400 | 240,800 | 30.94 |
| 2018 | 288,600 | 104,700 | 183,900 |
- Average free cash flow: $317.88 Million
- Average free cash flown growth rate: 14.3 %
- Coefficient of variability (lower numbers indicating more stability): 0.0 %
With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in WST have received an annualized dividend yield of 0.3% on their capital.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts.
West Pharmaceutical Services's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 9, so the company's assets may be overvalued compared to the average P/B ratio of the Health Care sector, which stands at 3.53 as of the third quarter of 2024.
With a higher P/E ratio than its sector average, a higher than Average P/B Ratio, and generally positive cash flows with an upwards trend, we can conclude that West Pharmaceutical Services is probably undervalued at current prices. The stock presents mixed growth prospects because of its strong operating margins with a positive growth rate, and an inflated PEG ratio.
