West Pharmaceutical Services, Inc. (WST) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to the last day of Bank of America's 2023 Healthcare Conference. And just happy everybody here, coming to you live from the Encore here in Las Vegas. I'm Derik De Bruin. And along with my colleague, Mike Ryskin, we're the Life Sciences and Diagnostics Tools team. And to kick off our conversation this morning is West Pharmaceutical Services. With us from West is Bernard Birkett, Senior Vice President and CFO; and Quintin Lai from Head of IR and also VP. Gentlemen, welcome. Thanks for being here. Thanks for making it out. And Quintin, I know you just got in from -- you flew in all the way from Dublin to be here. So I appreciate that. You're still on your feet. So thanks for that.

So let's start with discussing some of the points in your first quarter. Surprising mix, your 2.3% organic growth overall; proprietary products, flat; your CMO, up 14% organically; good strength in your core, offsetting COVID decline. Can you walk us through some of the puts and takes in quarters -- through the quarter? And also, I think there was a little bit of confusion on the proprietary product growth comments that were made. Can you sort of like clarify those?

Thanks for the invite, Derik. It's great to be here. We appreciate attending this conference. The first quarter was a good start for us. We saw strong growth across all areas of our business, and double-digit growth in biologics, same in generics and pharma. And we actually saw a nice rebound in our contract manufacturing business as well, coming off a slow year in 2022. So that was good to see. Again, as you said, we're offsetting a lot of the drop in the COVID revenues. And what we have been saying for a long time that our core business is strong, the demand remains strong, and that we saw that as we progress through the last couple of years, and that continues into 2023. From a -- also from a margin perspective, good performance we post, particularly in the first quarter. So pretty much in line with what we were thinking.

And with respect to -- thanks for that question. Yes, on the conference call, there was a little confusion. So there was a misspoke. Eric said on the prepared remarks, he said, we continue to expect mid-teens growth for proprietary. It meant to say, we continue high teens. And we tried to clean it up in the Q&A when someone asked to confirm. And yes, there's no change. So no change in the guidance from where we were in February. And as you look at the pacing for that, for the year, we're going to see increased capacity come online throughout the year, and that's going to really have a better impact here, Q3, Q4. So the way you should look at it for -- to get that is that we're not going to see the typical seasonality where Q2 and then dropped down Q3, 4, but instead there's a more steady rise through the year.

Got it. That is really helpful. So a lot of the conversations that we've had around the conference have related to inventory levels. I mean, there's been times in the past when West has had issues with customer inventories and inventory management, then managing working capital. There seems to be an issue that's more pronounced than some of the bioprocessing supply companies versus the component suppliers that you guys do. Can you talk about what you're sort of seeing in inventories? And why are you not as susceptible to destocking right now?

Yes. I believe that we're much closer to our customers now than we have been in the past and understanding their inventory positions. And it is something that we managed quite effectively as we move through COVID where, in some parts of our business, we had constraints. So we really had to manage the supply to customers. And what we were also conscious of as well during that time was inventory build. So we really were tracking to see, was there any purchase orders or buying patterns that were abnormal to what we have been seeing in the past? And if there were, it was really understanding with our customer, was that for stocking or was it for true demand? Because that helps us to be able to deliver the appropriate amount to customers while we were in a constrained environment. So I think that -- having that visibility has helped us as we've moved into 2023, where we are seeing some destocking. And we called it out as we went through the back end of last year is particularly around COVID. And you can see that our number has dropped and our forecast has dropped for 2023. We originally said $80 million. I think now we're saying about $60 million. So we are seeing in that area. What we're seeing more so is within the standard part of our portfolio, not HBPs but with the standard part, we're seeing customers manage their inventory more effectively. And now in some of those areas, we're replenishing stocks. We have a large backorder given the constraints that we had. So we are fulfilling some of those at this time. But we are seeing customers within the standard product area, manage their inventories. So that can impact the pacing of when we deliver, but not our overall growth in those areas. So it's just really working closely with our customers on that.

Got it. Just since I know we're all tired of talking about COVID. But since you did mention it, we've got some housekeeping. So is -- I mean, what we've been sorting to figure out is it's -- I mean $60 million on your relatively overall business is tiny at this point in time, right? But is there going to be some level, do you think going forward in this that -- I mean, I think we're modeling like $40 million for next year, but it's a complete guess.

Yes. And we're not guiding out to 2024 at this point. And it is a moving target. As we said, like 2 months ago, we were saying $80 million in February. And now we're saying $60 million. So it is moving fees. So it's very hard to predict for us. But as you said, it's become such a small part of our business. It's not something that -- it's something that we monitor. What we're more interested in seeing is, is there going to be a switch from large vials to smaller vials or to PFS and really understanding and trying to understand how that will play out over time, if it does. But today, like we have no more clarity on that.

Got it. Okay. Let's leave that there. So just remind everybody how much of your sales are tied to high-value products.

So about -- it was about 72% of our proprietary sales are high-value products. And that's been pretty consistent over the last number of quarters. So we are seeing that continued traction in the high-value product areas. So even if you look at the core growth, we're seeing that traction there, and that's supported by the level of investments that we're making across a number of our facilities. And just back to Quintin's point, we have a pretty large investment that we made in our Kinston facility coming online in the back half of this year. And we'd expect that to be into production pretty quick and then ramp as we go through the year. And that's where we're seeing that demand still coming. We're continuing to invest across all our high-value product plants. So Jersey Shore, Singapore, Eschweiler, Waterford and Kinston. And that is to support that growth, and it's both, for stoppers and plungers.

And so is the number that when you look at like new drugs that are coming out, and is the demand overwhelmingly towards the high-value products at this point in time when things -- like what is still the stand? Well, I guess you've got the $80 million. You still have a huge volume of standard products, right?

Yes, we have a huge -- it's probably that we'll call it 80-20 rule, and then that we convert about 100 basis points of volume to high-value products each year. But what we're seeing is the growth rate in high-value products outstrips the growth rate in our standard core products. And that's reflected in the growth of biologics, which has grown like that strong double digits. biologics is predominantly high-value products. And again, back to a point, that's where the investments are being directed to. And from an investment perspective and how it's allocated is typically our CapEx used to be 50% maintenance, 50% growth, give or take. Now what we're seeing is about 70% of our CapEx is growth-orientated. And so the payback is a lot faster, and it's targeted around high-value products. And where we're really seeing a lot of incremental demand is around our plunger business.

If you look at the biologic molecular entities that have been approved, I mean they almost always start at the coated HBP and very often move up from FluroTec to Envision FluroTec, or maybe even to NovaPure. And they're increasingly more on the NovaPure side from the recent approvals. And then on the ANDA side, the new molecules that are moving generic, several of those are also adopting our HBP because over the last few years, you know, you've been covering the company. We've been showing the benefits of having us wash and sterilize. And the AccelTRA line, for example, is getting good traction now.

Got it. And I asked you this on the call, but I've gotten asked again. So I'm going to ask it too, again. You didn't ask me in the call. But it's like it's this question of we've -- some companies will say if you spend x dollars on CapEx, you get x return in revenues that can generate, which your mix is different on this one, I guess, because it is like this -- is there a rule of thumb on -- I mean, so is there a rule of thumb of what -- how much you spend on CapEx and what the revenue generation can that be?

Typically, what we're looking at is -- looking at market demand and seeing where do we need to layer in capacity. And there are -- even within high-value products, there's a variation in the ASP and the margins that we can get. So we have to kind of look at it on a blended basis. And it's not in -- we don't communicate that information even from a competitive perspective, that's not something we want to do. But when we're looking at these investments, we have pretty strict criteria within our business when we're analyzing, where we should deploy this capital. And then also, we have to look over the kind of different time horizon. So it's not as if we start investing today and maybe you start generating revenues 12 months' time. Sometimes, we -- based on what we're seeing is we have to layer in capacity maybe 12, 24, 36 months in advance. So when we're looking out at our next tranche of capital allocation, we're looking out at '26, '27, because it takes that length of time to put it in place. The one thing that when we were doing that is we're not reliant on one customer or one product being successful. So we've got a portfolio that we're essentially investing in. And really, one of our main metrics is return on invested capital. And I think that's reflected in our numbers over the last couple of years and how that's been improving. So that's kind of more how we would look at it given the space we're in and the time horizon it takes for the investments. But again, it's -- from a risk perspective, it's pretty well managed because we're not -- again, not over reliant on one area or on one event taking place.

So this is a fabulous segue into it -- into my next kind of topic. So look, I think over the last few months, we certainly have had an uptick in interest from -- I would say, West historically has been a very specialist stock, right? I mean you sort of look at it, I've got a lot more interest in generalists, and this is all being driven by interest in GLP-1s and obesity and just like that. So -- and I think I've been trying -- the conversation I've been having with people is, well, look, I mean, these have been on the market for a while. They participated in these drugs. It's like they had to start building capacity years ago from when they saw things were coming on. So how should we think about what's -- I'm worried, just given all the calls that we've had that there are expectations that are very high, and it's going to -- and yes, while these drugs are going to be big classes, it's still going to take some time to sort of match that thing like this. So how should we sort of think about managing expectations for that?

Yes. It's hard for us to comment on a specific customer or a specific drug. But I would go back to, if I would use COVID as an example. So we had the same conversations around the response to COVID and vaccines and what does it mean. And even as we were layering in capacity at that time, people would always gravitate towards the COVID response. But what we were communicating was these investments for the growth in our business in any case. Now does the time horizon may be slightly different. But we, as a company, need to be making those investments, because the industry that we're participating in is growing, particularly as we talk around biologics, that's where we're seeing a lot of strong growth. And again, it's not just reliant on one customer, one product. That's an issue that I think we had a number of years ago, where the kind of -- it was concentrated on the number of customers and products, and we could get whipsaw pretty quick. Now we're not seeing that, because it's broadening. And that's what we want to see. And so we're supporting a number of like multiple customers, multiple products coming to market. Some will be successful, some won't be successful, and the timing of those successes is very hard for us to predict. So for us, it's layering in capacity on a phased basis. But the approach that we are taking now. And what we did learn from COVID is within certain parts of our business, we need to layer in capacity headroom. So we're able to flex a little bit more than we have been in the past. So we don't get tied up in these constraints, and it buys us time to be able to layer therein further capacity there. But again, that's just within very specific areas. So say around plunger. I want to make sure a headroom there and flexibility, so if there is a spine response. And so we take that kind of more holistic approach to it rather than looking at one area. And that's for other people to try and predict the timing and the size of markets. Not trying to be flippant, but I had this conversation with somebody who asked the same question. And they have all of this analysis that they said, okay, how accurate is it? I didn't get an answer. Like it's hard, it's very hard for us to predict, but we kind of use a level of statistical analysis and our understanding of the market and using history to help us understand, okay, what should our business look like? Where do we need to make the investments? And over what time horizon because we don't want to get over our [ skis ] either.

Right. Well also, I think it's the -- another question I've asked you is like how do you think about the margin mix of what you're putting in there? Because you could be -- some things are north of $1, some things are $0.30, right? There's a -- that HPV has got a big range of situations and trying to figure out the math. Because if you start doing units and this and that, you make some assumptions there, you get to some ginormous numbers, which I don't think you want out there.

I don't talk ginormous numbers anyway. It's -- I think with some of these things, the way we look at it, again, we look at our business as a portfolio. So we're taking, based on the demand, the information we're getting from a wide range of customers, we're able to model those things out, and then we have various scenarios that could take place. But for us to try and predict something like that, it just wouldn't be wide. I think from a West perspective, we kind of learned our lesson before that if you kind of try and predict something, you're answering questions on it forever. Our view now is to say, okay, let's control what we can control, put the capacity in place where we believe it's needed. And then let's see how it materializes. And when we can give greater clarity on that, more information, we will. But to throw something out there today, I don't think will be wise.

So in other words, if we build it, they will come, right? Is that the sort of a hope?