Shares of West Pharmaceutical Services Inc. (NYSE: WST) should be short sold due to declining revenue and net income, currency woes and high valuations. Another reason is that, after peaking during the fourth quarter of 2015, a correction appears to be looming on the horizon.
Company Background
West Pharmaceutical designs, manufactures and sells pharmaceutical packaging and delivery systems for drugs such as penicillin and insulin. The company was founded in 1923 and keeps its headquarters in Exton, Pennsylvania. West Pharmaceutical operates manufacturing plants in four continents and more than 10 countries, and employs over 6,000 people worldwide.
Declining Revenue
One of the best indicators of a good stock buy is rising revenue, and an excellent stock buy is suggested when revenue is increasing by over 20%. Revenue is what a company brings in from selling its products and services; it is exceedingly difficult to grow without increasing sales, and good stock performance is inexorably linked to growth.
West Pharmaceutical's revenue grew steadily from 2005 to 2014, but its rate of growth slowed during that period. Finally, between 2014 and 2015, the trend reversed course, with revenue declining slightly from $1.42 to $1.39 billion. While a 1.5% revenue drop is far from an apocalyptic sign, it is nonetheless inauspicious for a company that had previously enjoyed a decade of rising revenue.
Declining Net Income
Net income represents how much of its revenue a company gets to keep after expenses are paid. This figure is arguably more important than revenue, as big sales numbers are largely meaningless if they are washed out by oppressive expenses.
From 2014 to 2015, West Pharmaceutical's net income declined by a quarter, shrinking from $127 million to $95 million, due to the revenue drop and rising operating expenses that were mostly concentrated in the administrative realm.
Currency Woes
West Pharmaceutical conducts extensive business in China, Japan, England and Brazil. All have currencies that declined moderately to significantly versus the U.S. dollar throughout 2015, and thus far in early 2016. The Brazilian real's decline has been especially pronounced in recent years, falling from 60 cents on the dollar in 2012 to under 25 cents on the dollar in 2016. The Japanese yen fell under a penny in 2014 and continued to decline in 2015. In West Pharmaceutical's 2015 annual report, it noted that its 1.5% revenue drop would have been a 7.2% gain given a constant currency. With the dollar still strengthening, it is hard to imagine this not suppressing West Pharmaceutical's overseas revenue in 2016.
High Valuations
A good way to determine whether to go long or short on a stock is to compare its price to the company's earnings and book value. A company may have great fundamentals and impressive growth, but if these are already priced into the stock and then some, investors end up paying more than it is worth.
West Pharmaceutical's price-to-earnings (P/E) ratio, which compares share price to earnings per share (EPS), is 46.8. For the sake of comparison, an average stock trades at 15 times EPS. West's price-to-book (P/B) ratio, which compares the company's market value to what it is actually worth from an accounting perspective, is similarly high, at 4.3. Value investors like to see a figure under 2. By the most common valuation measures, this stock's price is too high and could be due for a fall.
Recent Stock Performance
Shares of West Pharmaceutical have lost 4.8% of their value thus far in early 2016, but they still trade toward the top of their 52-week range. This, combined with the fact that the stock price reached a sharp peak during fourth-quarter 2015 before receding, indicates it may be in the midst of a correction. If this is the case, shorting West Pharmaceutical shares could be a good way to log a quick profit.
