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

I'm Derik De Bruin, the senior life sciences and diagnostics tools analyst for Bank of America. Welcome to our 2023 Global Healthcare Conference. Our next company presenting today is West Pharmaceutical Services. With us today from West are CFO, Bernard Birkett; and IR Quintin Lai. Gentlemen, welcome. Thanks for making the trip over from Pennsylvania. I appreciate it.

Thank you. And thank you for the invite. It's good to be here.

Our pleasure. So a lot going on. So I'm not going to ask a question on GLPs at all. So because nobody is interested in that. So we'll just skip that. Do you want to sort of do opening comments in terms of where we are, in terms of like you just exited second quarter, strong demands across the business, CDMO up going? Just sort of -- I just want to set the stage and we'll take the conversation.

Yes. This year, we have been transitioning out of our COVID response. And things are progressing really well. We're seeing strong demand in our core business. We saw that again in Q2. If you drop off COVID, we're seeing that double-digit growth. And it's across nearly all areas of our business. And everything is performing in the ways we would have expected this year, achieving all our targets. I think a lot of the investments that we're doing, they're coming online performing in ways that we would expect the Kinston investment that we made. We saw that, that's come online this quarter and seeing -- making good progress there. So happy to see that. The demand is strong. We see it from across a number of areas in our business. And I know there's a lot of focus on 1 or 2 areas. And that's important. But for us, I think to see it across all areas of our business is really encouraging. And again, particularly in biologics, we're, I think from a customer point of view, getting our lead times back to normal levels. In certain areas, we were probably over 50 weeks. We brought that back down now to about 14 to 16 weeks, our target is 8 to 12 and we're making progress towards that. And by the end of the year, we should be pretty close on that. As we look forward, there is still a lot of work to be done. We have a number of investment projects that are going to be delivered over the next number of years. And again, a lot of those investments are informed by what we're seeing from a customer perspective and the demand and the forecast that they're communicating to us. So a lot of good work. The transition from COVID and out of that, it hasn't been seamless. It hasn't been easy. But from my sense, I think we've done a really good job on that and continuing with revenue growth, the margin performance, managing through inflationary periods and how we've adjusted to that and reorganized our business has been very positive.

So I want to touch on some of the headwinds that you had seen or some of the roll-off from COVID and some of the other things and inventories and stuff like that because they still keep coming up as questions. But your COVID number this year, I think it's $60 million, right, is sort of there. We're using roughly a $40 million-ish number for next year, just as a finger in the air. I mean, is that -- I mean, there shouldn't be -- I mean, it's not going to go to 0, but it probably doesn't grow either it's like. How are you sort of thinking about it for next year?

Yes. COVID, in our view, it's going to be -- it will probably be a decreasing number. What it is, I can't really call out today. But when you look at it in the whole context of our business now, it becomes pretty small. Now if there is a need -- a future need from customers for us to be able to ramp back up, we have the capacity to be able to do that and to support any shifts. But as of today, we haven't had any visibility on that.

Got it. Good. So -- and obviously, I mean, you talked about lead times coming down and obviously, there's a lot of concerns about inventories and stocking and such of that nature is like that as it hasn't really seemed to impact the company. I mean there's obviously been some going on with it, but it hasn't really matter because the other business has been growing. Do we need to worry about any of that, lead times come down?

We saw it was really around COVID and a number of other areas of our business, it was actually the opposite because we had to prioritize supply as we were going through '21 into '22. So that's why our backlog number, part of it was growing and the lead times we're getting out there. So we have been able to address that, and that's been important for us to be able to get down, to be able to level load our plants and have a more normalized production schedules and to deliver to customers when they actually want the product and in the time frame that they want us. And we have made significant progress there. So we didn't see a lot of customers essentially destocking. It happened in pockets. We saw it in certain areas. But again, it was offset by us having to bring those lead times down.

Got it. Your -- I mean, the industry is obviously going through a big -- say, transition right now, but I mean, we've covered this stock for a long time, and we've always been waiting for these big inflection points in terms of biologics and just sort of things going to be. And it really seems like the last couple of years, we sort of have seen this coming through. This has -- but that's also a delicate transition as you've got to ramp up capacity, you've got to timing, you've got to forecast what your customers are doing. So when you look at the demand out there and your capacity and what's going on with it, I mean, is that properly aligned? Or is there still some risk of mistiming of that?

Yes, trying to get the timing perfect is like that, that can be challenging. From our perspective, we are now in a much better position with matching demand with supply. We took some decisions a number of years ago to layer in extra capacity and expand our Kinston facility. And we have further plans to invest in our -- continue the investments in our HVP sites across the network. But as of today, we will be able to respond to any immediate demand that we call. And as I said, this year, our focus is on reducing the backlog. And if -- when demand comes, we will be able to respond. And it's -- we're working closely with our customers, understanding what's happening with the market, trying to get a sense of what those inflection points are and to layering capacity ahead of time while not going way out over skeezy. And so it's striking that balance. So one of the approaches, we're operating at a certain level. We've targeted levels of utilization. And then -- but in certain areas, we know that if there was a spike in demand that we could be constrained. So we're proactively layering in some flex capacity in those areas, particularly when lead times for equipment could be 24 months plus, and that will put us in a bit of a bind. So to address that, we're taking the learnings from COVID and in specific areas, making sure we have that capacity. But we're not going to be overburdened with that either the carry cost, won't be -- won't impact any of the guidance that we would give our long-term construct. And also is looking at how we're going to leverage our network and how can we optimize that in a more efficient way than we have in the past by having customers to be able to pull product from different sites and not being constrained just by getting product from 1 site. So there's a number of different things that we're looking at and plus the levels of automation that we will be introducing will actually increase our throughput over the next number of years, and that gives us a level of flexibility that we need to respond to any kind of major spike that would happen in the market.

So it sounds like then you're doing about $350 million in CapEx this year. So it should -- CapEx should start to ramp down in '24, '25 as you...

We're going through our CapEx planning really locking down '24. So I can't give you guidance on it today. But what I would say is that the CapEx that we're deploying right now, the 70% of that is targeted towards growth, where pre-COVID 50% of the CapEx sort of being targeted towards growth. So a different dynamic. And what we are looking at is to say that if the demand is there, we will deploy the capital to be able to meet it and maybe even a little bit ahead of time. So there are some of the things we're working through at the moment as the landscape is shifting. So again, as soon as we have more information on that, we'll share it.

So the whole point of this being is like I've had some investors who are worried that you're adding capacity and it's not going to get filled, right? That's sort of the gist of all those questions like that. But you're pretty -- you feel like you're completely matched. You know it's coming, right.

We pressure test this on a regular basis. And even after we made decisions, we will go back and review them as the market demand is shifting to make sure that the assumptions we based our original thesis on are correct. So it's an iterative process. It's not just a one and done, and we blindly go and add capacity. And again, we had to learn from the last number of years. And if you get too far behind the curve, you actually start to constrain your business. So it's striking the right balance. And what I would point to is the level of growth that we've seen over the last number of years, the capital that we deployed is needed for that growth. I think I was saying to Quintin earlier when I joined, West was circa $1.5 billion, $1.6 billion, something like that. Today, it's $3 billion, and that's just over 5 years. And so that's considerable growth. And then it's investing. You're seeing it in growth in high-value products, which is different levels of technology. And so you have to support them. So I think we're pretty prudent in how we do it. And a lot -- it is informed by customer conversations, what we're seeing in the market and where we see demand coming from. So we're not blindly adding capacity and just look at the returns, look at the expansion in operating margin, the return on invested capital over the last number of years, it shows that those investments are paying off.

Got it. So this is all a setup and ask the...

Ask Quintin a question.

Ask Quintin a question. Yes. Well, no, I mean, it's a set up that is, is like, obviously, the stock has had a phenomenal move and people responded to it. And because there's a lot of interest in some of the new modalities out there, there's a lot of interest in the GLP-1s with this. And so you're growing 10% on your -- business is growing 10% this year, growing double digits this year, ex-COVID on the core business. And I think the question is like is that level of growth sustainable? As you sort of see all these different biologics coming through the GLPs, all these things coming through, is that level of growth sustainable because your algorithm is a 7% to 9% top line growth like that. And so that sort of is the big debate on the stock right now is like is that level of growth sustainable? Or these are going to be some sort of transition next year, where there's passings not quite there, the time is not quite there. So that's -- I think that's where 90% of my questions sort of coming from investors right now.

Yes. I said, we have been layering in capacity and it's for a reason. So my sense is we are much better aligned with demand and supply now and to be able to respond to the market. And if there is a spike in demand, we're ready, and we have made the investments. Timing that can shift, that's not -- there's some things in our control, some are not. What I would say is that we're as prepared as we can be.

Got it.

That will be the way to say it.

Yes. Okay. Good enough.

But I would also say we're not reliant just on one shift in the market. We're supporting many customers with many products, many disease states. So our investments just aren't based on one item either. So...

Yes. Let me just add to that. So the long-term financial construct, Derik, that people ask, well, why don't you move it? Again, our long-term financial construct is based off of a combination of macro individual customers, portfolio of customers, our ability to affect certain things. And it's not predicated on a breakout. It's not predicated on 1 customer or 1 drug class. We look at it from a portfolio because we deal with thousands of customers and each one of them have potentially multiple drugs that are using. West packaging and containment and delivery. So now in the event that there is something that breaks out, then that's additive to the long-term construct.

Got it. And that 7% to 9% then sort of drives at least 100 basis points of op margin expansion. And clearly, you're adding capacity for your high-value products, which is primarily going there. So is -- can we talk about the puts and takes on the margin in terms of -- you obviously have to absorb capacity. You've got the mix shift going on, you've got inflationary pressures. Just sort of talk about how we sort of think about that 100 basis points.

Yes. The typical driver for the 100 basis points is mix shift and driving high-value products, and that still stands. That is the main driver. There is some price in there as well, and we have been able to being get more price over the last number of years. We did this year, we're probably going to do between 5% to 6%. That's probably north of where we would typically be given that we had to cover some of these inflationary pressures. And that was part of being able to do that and manage that cost base, but we're also driving a lot of cost efficiencies and operational excellence within our business. So taking cost out, becoming a lot more efficient, introducing higher levels of automation, better throughput. So there's a number of drivers there. So you've got the mix, the price and then the operational efficiencies that they are essentially the main drivers of that margin. And that's been the story over the last number of years, but mix is always going to be the primary one.

I mean, are your competitors -- where are you taking price rise? Is it mostly at the high end of the system or you're doing it across even the lowers?

It's across the business, but it varies between different elements, some areas on core legacy business, there isn't as much opportunity to take price there. It's just the nature of that business and the competitive forces.

And speaking of the competitive dynamics, I mean, obviously, there's a lot more competition at the lower end and the higher end of the chain on this. And I mean are your competitors behaving rationally? And you have 2 major ones, right? I mean so are the competitors behaving rationally? Are they trying to discount? Are they trying to do that? Are they taking prices on similar levels?

Yes. We haven't seen any change. There's always been an active community of suppliers that are supporting our customers. We have a lot of respect for our supplier -- the other suppliers in the area. We focus a lot on what we do. And I'd say that there hasn't been a real change in the overall market because they've always been there, and they've always been active and having active dialogue with the customers. I think from the customers' point of view, everyone has gone through the pandemic with higher acknowledgment of the importance of the supply chain. So that has -- that goes without saying. So everyone is looking at what can suppliers do to give them more confidence, right? What we've been doing is we've been expanding our network. We've been standardizing a lot of our processes. We're getting to the point where you can source from a variety of different HVP sites through more standardized processes. And so that's the assurance that we're giving to our customers. The other driver that is going on right now is that the regulators continue to raise the bar, whether it be on particulates or extractables, whether it be Annex 1, all of these things that are going out there that are pushing the level up higher. And when that happens, the customers then come back to the suppliers and go how can you solve that? And that's where our high-value product portfolio, the vast amount of technical customer support we have, scientific insights, supports that we have, that's where we think that we can provide a lot of value add to our customers. And that's what we've been focusing on.

Got it. So I have to now go into the obvious GLP-1 questions you already [indiscernible] Can you remind us how West is playing in that market? And sort of like how we should think about -- whatever you said on sort of like remind us on unit pricing realized, this is like because I think people are all trying to solve for X given we're also we're seeing this demand. We know there's some limited numbers. Like how should we think about this opportunity for the company?

So as opposed to talking about a specific disease state, what we remind everybody is that West is the market leader in elastomeric closures, stoppers, plungers, and those go to vials, prefilled syringes and cartridges. So if an injectable drug goes into one of those categories, West can participate. If it goes into the category of like a cartridge or a prefilled syringe that would go into an auto injector then we'd also have another opportunity to participate because we have a contract manufacturing business, this high-volume, high-precision injection molding, plastic injection molding, so we can make the assembly, we can make the components and assemble. So if an injectable drug were to fall into those categories, then we would be participating on the elastomer and potentially on the contract manufacturing side.

Got it. Yes. Thank you for awaiting the questions. But I guess -- so you've seen -- I mean, you've seen some of the estimates that us and other analysts and the buy-side has put out on there. Are you -- how do we sort of -- I mean, look, I mean, these are obviously not new drugs because you've been participating in these for a while, right? I mean they've been on the market for a while. So how should we think about the incremental opportunity from these sort of like -- you obviously were building capacity because you saw demand coming. How do we think about that incremental opportunity, though, since the demand of it has been sort of off the charts.

Maybe I can take a step. The -- first, with -- when we look at capacity, right? And we're talking with a variety of customers, we have a 5-year STRAP plan. And that 5-year STRAP plan is evergreen. So if you remember in 2020, when COVID was just kicking off and the vaccine manufacturers were starting to do their just studies to whether or not they -- they were already giving us feedback at that time saying, "Hey, look, if it hits, we'll need this. So what we did was we proactively moved to move some of those plans forward, which meant that we then had to redo a new 5-year STRAP plan because a lot of that got moved forward. And as COVID continued, we continued to move forward. As COVID waned, we continued to move forward. But the reason why now is that the base business was also moving and the base business includes a lot of the new injectable drugs that are coming out. Because we do it in phases, it gives us that ability need to flex because forecasts are uncertain. And so -- and there's sometimes big variation. And sometimes the updates can be very varied. So that's why we have these different phases to be able to bring that in. But when you see incremental HVP sales like you did with COVID, you see what happens to gross margins.

Yes. Got it. The -- outside of CapEx, the company does not have a history of doing acquisitions. I mean you've always done internal investment like this. And you -- obviously, you looked at wearables, you do some of these things like this. I mean is -- when you look at this the business going forward, is there any sort of like technology, any reason to sort of move away from what you're currently core doing to look for other opportunities?

I wouldn't say we'd move away from anything we're doing. But the opportunity to invest or further invest to build out some of these platforms is definitely there. And that will be around wearables, drug delivery and expanding that product offering and platform. And that we have seen more interest from customers around that area over the last number of years, and that interest is continuing to grow. And so that is an area where we are further exploring to deploy capital. We have nothing to really announce or specifically talk about today. But we're now in a much stronger position, I believe, as an organization, ready to be able to go and do that. Over the last number of years, it was really building out the organic story, making sure that we could deliver on it consistently, which I believe we're now doing, then responding to COVID that really put a lot of pressure on our organization. We've come through that. We've learned a lot. And we've built out a lot of capability within our organization. We've been adding over the last number of years from a personnel perspective. So for us now to be able to go, we're in a position to be able to go and now pursue M&A more proactively than we have been doing in the past. And so that there are a couple of areas that we do want to target.

So on the CMO map, on the CMO segment, historically, you've talked about that as sort of like a mid-single-digit growth rate business just because those contracts are not as long as sticky as what you have. Is that still the right -- I mean, yes, you're currently doing some syringe assembly like that, is that mid-single digit for that business still the right way? And I guess what others -- you did some consumer product stuff at one time. Now you don't do it as much. You've moved stuff in and out. I'm old enough to have picked up the stock when the Exubera thing came off that years ago and sort of knowing how volatile that business can be going with it. So what's the right way to sort of think about that segment?

Yes. We would look at that segment as like mid-single-digit grower over like it's a much more competitive space. The number of players that are in there, how the contracts are shared out is very different to our proprietary business. But what we're targeting is that mid-single-digit growth, probably at the bottom end of our construct. And again, it's also managing the mix. And the returns on that business aren't the same as in our proprietary business. So we have to manage that carefully. But it still -- it generates a lot of cash for us. The returns are positive. But we're very targeted in the business that we go after in that area. And so it is, as you said, we used to be in consumer products and so we moved out of that. It's very health care focused at the moment. And even within that, it is very targeted. So mid-single digits. And again, it's just managing us, so it doesn't have the impact it had probably a couple of years ago when it was growing faster than proprietary, or mix issue, and we couldn't expand margins. It's understanding that it is a really good business for us. We get returns that we're happy with, given the level of investment that we have to make, but we manage it within the portfolio.

So I have to also ask the inevitable China question. And your business exposure there, competitive dynamic in that market, how do you see that evolving current dynamics there being a little bit uncertain. So how much is China? How important is China to your overall strategy and growth opportunity?

The customers that we work with in China are important to us, and we see a pathway to growing business in China over the coming years. We have invested in infrastructure there and within Asia in general to support growth in that market. Today, it's a pretty small part of our business. I think China, Asia and Latin America is probably less than 10% of our revenues. What we do in China really is kind of local for local. So we're not overly exposed there. But from an Asia perspective, we do see the opportunity to grow faster in some of those markets, probably than in -- compared to some of our more traditional markets but it's still relatively small. So we're not overexposed. We don't have any major issue there.

And you're not -- the current economic slowdown shouldn't -- is that impacting the business at all?

Not really, we've seen a little bit of pullback in some areas. But from an organizational point of view, it's not really material to us, given the small exposure.

As a reminder, most of our sales are from the commercial production and we do very little in clinical, even less in preclinical, if any, and none in discovery. And so in those areas that might have funding challenges upstream, we don't participate.

Yes. How much -- so questions I keep getting from investors just I mean I know the answer to this, but I'm going to put them out there because I keep getting them. But how much of your business is take or pay? And how much of your business is tied to the price of the drug that's out there, I mean, given the concerns of a drug pricing debates and people pushing back on it.

Yes, we're not -- our price isn't linked to the price of the drug that. They're like separately negotiated. So that wouldn't be an issue for us. I'm sure we could get pressure, but it's not tied. There's no mechanism there to just bring our pricing down.

Right.

And in terms of take-or-pay, yes, we -- other than some cases in COVID were for the most part, our proprietary business, really not a model that we use.

Great. Thanks. But I keep getting asked of questions on it quite a bit. So let's just clarify it. Any questions from the audience?

Going back to the CapEx discussion earlier. Can you provide any color on the CapEx investments you're making now? Are they -- I imagine they're gearing more towards HVPs, but anything you can clarify there in terms of prefilled syringes or where you're making those investments. And in terms of timelines when that comes online, is that from initial investment to when you're start producing product is a year or 2 right way to think about when that starts to contribute?

Yes. So most of the growth CapEx is targeted towards HVPs. And it's across at different levels, it's across each of our HVP sites as to -- we're continuously making investments. The largest one, obviously, that we just completed was Kinston, and that came online here in the third quarter. And we'll build up the levels of utilization over the next couple of months within that plant. But typically, if some of the capital projects, you could be looking at 2 years from inception to getting the equipment in validators to when it goes into production. So it's a relatively long period of time, and that's why we have to be planning ahead of the curve and making the investments now to be ready for, say, '23, so for 2025. 2025 and beyond, we're already laying down investments in many of our plants. And again, they're at various stages. The bigger ones we would typically call out.

The margin differential between high value and standard products is -- can you sort of like go through that? And because that's another one extra that comes up in questions all the time. And also, at the NovaPure high of the range. Is there much competition for that product? I mean most of your competition, I think, tends to be at below that level. But can you sort of talk about at the very high end of the range and the margin?

I'll do the margin and then Quintin will get into the competition piece. But yes, for a standard product, you could be at the lowest end, 25% margin. and then you're building to margins on the highest end, would be 70%, 80% margin on those products. But what happens is on some of the standard products, you don't have as much R&D going in SG&A. So that's -- once you get below the line, those different splits. But yes, it varies considerably, and that's why it's -- the mix shift is so important. To drive revenue growth and then to drive that operating margin expansion. And we've seen the power of that as we went through COVID when we got a lot of mix shift in a pretty short space of time. You could see the top line growth was pretty good, but the margin expansion was very, very strong and way beyond 100 basis points. So it shows what an event like that could -- if it was that extreme. Now there's a lot in the middle as well. So we have typically probably 40%, 50% margin on the high-value products will be the average. And so -- but with the changes that are happening in the regulatory environment with Annex 1. We're seeing the drive to move products of that high-value product curve, and that's what customers are looking for because they want to reduce the levels of particulates and they want that guarantee. And that's these product offerings that we have in place. deliver on that.

With respect to NovaPure, I mean, looking at NovaPure, it is the pinnacle of what we do. It's got all the various high-value processing. We do quality by design in every step of the manufacturing. My assumption is that other suppliers also do a lot of the different processing. They do various checks, but it comes down to comparing us versus somebody else comes out to the rubber. It comes down to the coating. It comes down to all of the technical support and all that. And so it's one thing to say, yes, I have something similar. But the question is, is it apples-to-apples? Is it elastomer that is being used on many of the injectable drugs that are being approved now. Is it the fluoropolymer coating that's being used? Is it the technical support that is being used to roll it out to various countries, right? Not just because these days, a drug doesn't get rolled out in the U.S. Right after that, it gets rolled out into this and do they have a -- all of the back office things, that's what you get when you're getting a West product. It's not just a piece of rubber. It's quite a bit of that extra support that supports all of that.

But I mean that's a great answer because I think there is a misconception that all you do is sell chunks of stock...

No. The way we look at it, I mean -- I was making the analogy with one of my colleagues as we were walking the halls. And I said, it's just the ice you see at the top, the rubber, the iceberg, that's what everybody -- that's what the analytical labs are. That's what all this department is, someone who is new to the company. And we're walking -- that is all that it goes to support that piece of rubber.

So since you used the word iceberg, I'll ask, what makes you worried? Is there an iceberg out there that you look in the business and like what keeps you up at night and because it's a great story. It has been for years. And I think people just sort of by pinching themselves like what can go wrong?

You can join me for a day, and I can show you. We have a great company. We're in a great space but to keep at the level we're at, it requires to be at the highest levels of execution and performance. And you're running like we have to make sure that we're giving our customers what they want when they need it. And that becomes more challenging every day because the bar is raising what they want, and we have to keep improving as a company to be able to do that. So there are challenges out there. Making these products is not easy. It's not a slam dunk. People think it's a piece of rubber, it must take a couple of minutes. If you actually go through and understand the process and particularly for something like NovaPure, it's very, very technical, and you're dealing with like micro parts. So there are challenges there day-to-day. But my belief is we have the right people in place to deal with them. We have the right technology and infrastructure. That's why we keep vesting and building on it. We're not ever standing still even from an automation point of view as to how we build the product. And we're starting to push the boundaries on that and introducing these newer technologies, making sure they work yet, does it keep me up at night? I have trust in the people that I work with but it still keeps me up. And again, it's just meeting customer needs and demands and being able to respond. It's responding to the unknown, I think, is a challenge in today's world. And again, as I go back, the last couple of years told us a lot, nobody could have predicted that but we did this but it was very difficult. And now we're learning how to respond in a different way so we can respond quicker and more efficiently in an ever-changing world. And I think there are the challenges. Do they keep us up at night? We think a lot about them. But we are in a great business. We're a great position. But we just have to keep executing.

And with that, we're out of time. Thank you, gentlemen for being here. Thanks all for listening.

Thank you, Derik. Really appreciate it.