Steris plc

Moat: 2.5/5

Understandability: 3/5

Balance Sheet Health: 3.5/5

STERIS plc provides a variety of healthcare, medical device, and biopharmaceutical products and services, and its core business is infection prevention, contamination control, and surgical support.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

STERIS plc operates through three primary segments: Healthcare, Applied Sterilization Technologies (AST), and Life Sciences. Let’s take a closer look at each:

Healthcare: This segment provides a range of products and services designed to prevent infections and facilitate efficient surgical operations. This includes sterilization equipment, surgical tables, instrument management systems, and other infection control solutions. It serves healthcare providers worldwide.
Applied Sterilization Technologies (AST): This segment offers outsourced contract sterilization services for medical devices and pharmaceutical products, among others. STERIS uses various methods of sterilization, such as gamma and electron beam irradiation, and ethylene oxide. It serves a wide variety of customers including pharmaceutical companies, medical device manufacturers, and more.
Life Sciences: This segment provides a portfolio of products and services for biopharmaceutical and life science research companies that need to maintain highly clean and controlled environments. This includes equipment for sterilization, cleaning, and contamination control used in cleanrooms and laboratories.

Revenues Distribution (Fiscal Year Ended March 31, 2024)

Healthcare: This segment continues to be the largest revenue contributor for the company, accounting for around 70% of overall revenue. Growth in this segment has historically been driven by the growth in the global healthcare industry, as well as the company’s ability to capture market share with its differentiated products and services.
AST: The sterilization technologies segment continues to be a stable contributor to revenue, accounting for around 15% of the total. Revenue is tied with the demand for third-party sterilization services.
Life Sciences: Contributes the rest of the revenue. This segment is volatile because companies in biotech and pharma industries can have highly varying business results.

Industry Trends and Competitive Landscape

Healthcare: Growth in the healthcare sector is influenced by several factors, including the rising global healthcare spending, the demand for new and improved medical devices and procedures, and regulatory changes aimed at improving infection control in hospitals and health facilities. The industry is quite competitive, with a mix of large and small companies that offer solutions in niche areas.
AST: The demand for outsourced sterilization services will continue to grow as it is extremely important to maintain a high level of control of any kind of pathogens and to adhere to increasingly difficult regulations. In this segment Steris is competing mostly with small regional players. They are also facing increasing scrutiny with the ethical impact of EtO sterilization.
Life Sciences: The demand of the life sciences market is tied to the health of the market of research and development spending from biotech and pharmaceutical companies. With significant and consistent amount of investment happening in biotechnology and pharmaceutical companies, companies that have strong relationships with them should expect to grow.

What Makes STE Different

STERIS differentiates itself in several ways:

It provides all components of infection prevention, offering both products and services. Most companies focus on only one part of the process, either by offering equipment and software, or by providing services.
Its recurring business model (which is mostly driven by services) gives it greater predictability over revenue.
The geographical spread of its customers and facilities means that it has a larger presence across the world than many other smaller companies.
They are not dependent on one particular country’s economic conditions, this reduces cyclicality.

Financials Deep Dive

Analyzing STERIS’s financial performance reveals several key areas:

Revenue Growth: The company’s revenue has shown consistent growth over the past years, driven by both organic expansion and strategic acquisitions. Their most recent earnings reported a revenue of $1.27 billion for the 3 months ended September 30, 2023, compared to $1.19 billion for the same period last year. This is a 6.6% increase in revenues.
Profitability: While the gross profit margins have been relatively stable, the operating profit margin has seen some volatility due to higher operating costs and restructuring activities. The consolidated statement of income as of September 30, 2023, shows a gross profit of $685.1 million, a 53.8% gross profit margin, which is up from 53.2% gross profit margin from the same period last year. Operating margin however decreased to 14.5% from 16.4% from the same period last year.
Operating Profit: One of their largest and most profitable segment is the healthcare unit. The other two segments contribute much less to total operating profits. Most of their operations are based in the US but their sales are spread all over the world.
Capital Spending: The company has kept it’s capital expenditure stable, which has allowed them to consistently create revenue and profits at a lower incremental capital outlay, this is visible in good ROICs over the last few years. Their Free Cash Flow is consistently above reported net income due to high depreciation and amortization charges.
Debt and Leverage: The company’s debt to equity ratio has increased recently due to acquisitions, which makes them more risky. However, given consistent profitability, and cash generation, this debt level is manageable.

Moat Assessment: 2.5 / 5

STERIS possesses a narrow economic moat that is based on a combination of the following characteristics:

Customer Switching Costs: Many of STE’s products, especially in the Healthcare segment, are integrated into hospitals and labs, and therefore, customers are more reluctant to switch to new providers, especially considering the impact that could have on operations.
Regulatory Approval: Obtaining and retaining regulatory approvals is onerous, and can create a barrier to new entrants into the market for sterilization equipment, devices, and services.
Brand Recognition: Steris has managed to create brand recognition by providing superior quality and reliable services. This allows the company to retain and acquire customers easily.
Economies of Scale: Being able to offer different modes of sterilization, and also a large variety of products and services across different segments allows them to serve and obtain larger clients as well. This enables economies of scale, giving pricing and profitability advantages.

The biggest risk to Steris and its moat is new disruptive technologies that might appear and change the dynamics of its market. Furthermore, a large acquisition may also disrupt the company. Because of these risks, we believe their moat is not wide, rather narrow.

Legitimate Risks to the Moat and Business Resilience

Technological disruption: The core of Steris’s business relies on a limited amount of methods of sterilization and cleaning. The company’s moat will be threatened by a new, cheaper, and more effective form of cleaning or sterilization.
Ethylene Oxide (EtO) Controversy: Recent regulatory scrutiny on EtO sterilization poses an important threat to the company. The EtO method has faced a lot of backlash lately, and some local governments in the US have increased their scrutiny on the method. EtO provides more than half the Steris’s total revenue, and therefore, this risk has to be looked at carefully.
Acquisition Risk: Steris is an active acquirer. It’s acquisition strategy makes them more prone to overpaying or picking companies that have limited moat, and can potentially lead to shareholder value destruction if the acquired companies don’t perform.
Government Regulation Changes: New laws and regulations can increase the cost and time taken by a company to bring its products to the market, giving potential competitors a chance to create or widen their own moats. This is especially a challenge for Steris since they operate in heavily regulated industries and regions, such as healthcare and Europe.
Economic Downturns: Any large and prolonged economic downturn can affect healthcare spending, which, in turn, may limit the profitability of Steris.

The company’s financial health is resilient enough to face many short-term challenges, however, it may be affected long-term if the aforementioned risk plays out.

Business Understandability: 3/5

While the different segments of Steris may sound slightly complex to new investors, it is not a complicated business to understand. They have a few product offerings, and provide services that are not inherently difficult to comprehend. With some effort, investors should be able to analyze and model the business. The multi-business nature of the company along with the intricacies of different markets means that the company is more complicated to understand and follow than a single-business company.

Balance Sheet Health: 3.5 / 5

The company has a decent balance sheet, however, a couple of important points need to be noted.

The company has been consistently acquiring smaller companies which resulted in increased intangible assets on the balance sheet and, to some degree, goodwill.
Debt has increased to finance the acquisitions, but is still manageable with their revenue and free cash flow.