Fitch Assigns First-Time IDR of 'BBB' to STERIS plc; Outlook Stable
(The following statement was released by the rating agency)Fitch Ratings-Austin-17 March 2021:
Fitch Ratings has assigned a first-time Issuer Default Ratings (IDR) of 'BBB'/Stable Outlook to STERIS plc (STERIS), STERIS Corporation and STERIS Limited in conjunction with its pending acquisition of Cantel Medical Corporation (Cantel) for $4.6 billion. Fitch also assigned 'BBB' ratings to the senior unsecured credit facilities and existing notes.
The 'BBB' IDRs contemplate the combined company's comprehensive product offering in infection prevention and leading national positions in its healthcare segment, offset in part by a narrower product and geographic focus compared with other 'BBB' rated peers.
The ratings also reflect the company's modest leverage and sufficient financial flexibility. Fitch expects the company will operate with gross debt/EBITDA of roughly 3.0x upon transaction close assuming a full year's contributions. Over the medium-to-long term, Fitch expects leverage will be between 2.0x and 3.0x depending on acquisitions and settle around 2.5x as Fitch believes the rationale for strategic M&A will remain intact.
Key Rating Drivers
Combination Supports Growth; Less Diversified: STERIS' proposed acquisition of Cantel will provide a broader, more comprehensive selection of infection prevention and procedural products and services to hospitals and surgery centers, medical device manufacturers and pharmaceutical production. The combined product offering should position the company to meet more customer needs for the growth areas in healthcare, including procedures, devices, vaccines, biologics and dental and support a mid-single digit growth profile over the long term. The acquisitions of Cantel and Key Surgical, Inc. (closed November 2020 for $850 million) also better position the company to pursue growth in international markets.
The acquisition of Cantel also increases the company's presence in endoscopy and creates the broadest infection prevention offering for national hospital providers. Cantel's dental business presents a new customer base for STERIS, and will continue to be a growth area as the pandemic has increased the focus on infection prevention protocols within dentistry. However, Fitch views STERIS to be less diversified than comparably rated peers in terms of products and geographies.
Recurring Revenue Supports FCF: The combined company's business model will generate 78% of revenue through recurring products and services, helping to support consistent EBITDA and FCF margins. STERIS's services offering and long-term customer relationships and contracts also provides stickiness for the business. Fitch expects the combined company to generate EBITDA margins around 30% and FCF margins between 8%-10% in FY 2022-2023. Healthcare providers will remain the company's largest customer group, and the acquisition of Cantel should help STERIS maintain more pricing power against GPOs and integrated delivery networks (IDNs), supporting the assumption for stable EBITDA margins.
Leverage to Moderate: Fitch expects STERIS' leverage will decline toward 2.7x by FYE2022 assuming realization of stated synergies, revenue growth of 4%-6% and some debt reduction. This compares with leverage of approximately 3.0x at closing after the issuance of an additional $2 billion of debt and 2.1x at Dec. 31, 2020. Fitch views STERIS' cost synergy guidance of $110 million with roughly half achieved in the first two years to be achievable. This view is supported by management's track record with realizing cost synergies and reducing leverage after previous acquisitions, albeit ones not as large. The proposed capital structure should allow for continued flexibility to sufficiently invest, both internally and externally, while maintaining the 'BBB' IDR.
STERIS has been a consolidator in the space, but has been mindful of its balance sheet in the process. The use of equity to partially finance larger deals and a history of debt reduction following leveraging transactions supports this view. Fitch expects STERIS to maintain gross debt/EBITDA around 2.5x, at the 'BBB' IDR level. The agency notes that leverage may fluctuate below this level during periods without M&A and above when consummating M&A, but anticipates the company will continue to delever following deals.
Coronavirus Impact Net Positive: The essential nature of STERIS' products presented both benefits and challenges to product demand during the pandemic, resulting in the expectation for low-single-digit growth for FY2021. As there is a sizable component of procedural-based demand in the Healthcare segment (59% of pro forma revenue), deferred elective procedures resulted in dampened revenue. The Life Sciences and Applied Sterilization Technologies (AST) segments experienced increased demand for products and services focused on vaccines and biologics as well as testing materials and personal protective equipment. Heightened focus on infection prevention and sterilization post-pandemic, coupled with expected business demand normalization through the company's FY2022 should allow for total company growth to return to mid-single digits.
STERIS plc is a leading provider of infection prevention and procedural products and services. While STERIS has leading national scale and global reach, it is smaller and has a narrower focus than its largest medical device competitors. STERIS' demand is normally relatively reliable, although sensitive to the macroeconomic environment through reimbursement rates (pricing) and, to a lesser extent, utilization.
The ratings of STERIS's medical device peers, Zimmer Biomet Holdings, Inc. (BBB/Stable) and Boston Scientific Corp. (BBB/Stable), are considered in the analysis, but product offerings vary widely across the group and these issuers have greater global scale. Fitch also considers peers PerkinElmer, Inc. (BBB/Stable) and Bio-Rad Laboratories, Inc. (BBB/Stable) given similar scale and highly recurring revenue sources, but notes greater end market diversification among these diagnostic peers. Fitch looks for all of these peers to maintain gross debt/EBITDA between 2.5x-3.0x.
Fitch's Key Assumptions Within the Rating Case for the Issuer
--Coronavirus impact mixed across segments, resulting in weaker growth for FY2021; increased demand for infection prevention and sterilization products/services largely in healthcare end markets offset some pressures in medical device end markets and lower demand for capital equipment;
--Cantel Medical assumed close of June 30, 2021; nine months of Cantel Medical results included in Steris' 2022 fiscal year ended March 31, 2022;
--Mid- to high-single-digit combined organic revenue growth largely driven by end market tailwinds, and some new product introduction;
--EBITDA margins increase over FY2021 and FY 2022 as the company extracts some operating costs; assumes $110 million of synergies over four years, with 50% achieved in first two years;
--Debt reduction through annual term loan amortization; private placement notes assumed to be repaid at maturity;
--Assumes tuck in acquisitions resume in FY2023; share repurchases minimal to offset dilution;
--FCF margins of high single-digit to low double-digits, improving largely from stronger EBITDA margins;
--Total debt/EBITDA expected to be between 2.5x-3.0x in FY2022, deleveraging to low 2.0x in outer years.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--STERIS increases diversification through both product lines and geographic expansion, while consistently maintaining gross debt/EBITDA below 2.5x;
--STERIS exhibits strong operating performance and durable FCF, resulting in (cash from operations-capex)/debt at or above 15%.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--STERIS operates with gross debt/EBITDA sustained above 3.0x, possibly due to sustained operational deterioration or a more aggressive capital deployment strategy;
--STERIS fails to generate stable operating performance and FCF materially and durably deteriorates resulting in (cash from operations-capex)/debt sustained below 10%.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Liquidity Solid: STERIS maintains a solid liquidity profile through $253 million of cash on hand and a $1 billion unsecured committed revolver due March 2023 as of Dec. 31, 2020. Stable FCF generation and access to liquidity should be sufficient to support operating requirements, capex and common dividends.
Maturities Laddered: STERIS generally has a well-laddered maturity schedule, with private placement note maturities staggered annually. Fitch expects some debt reduction through term loan amortization and some private placement repayment upon maturity, but expects some debt could be refinanced at similar or better rate in the outer year of the forecast.
Date of Relevant Committee 01 March 2021
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STERIS plc; Long Term Issuer Default Rating; New Rating; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; New Rating; BBB
STERIS Limited; Long Term Issuer Default Rating; New Rating; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; New Rating; BBB
STERIS Corporation; Long Term Issuer Default Rating; New Rating; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; New Rating; BBB
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