Uncategorized

STE curve too steep relative to peers

| April 9, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The 10s/30s curve of STERIS Plc (STE) (Baa2/BBB-/BBB) is steeper than that of similarly rated peers who also recently tapped the bond market, including PerkinElmer Inc (PKI – Baa3/BBB/BBB). STE trades roughly 13 bp behind PKI in the 10-year part of the curve, but nearly 25 bp back in the 30-year.  While PKI has a slightly larger capital structure it only has three index-eligible USD bonds outstanding totaling $1.65 billion versus two at STE totaling $1.35 billion; so the case for PKI being more liquid is not necessarily valid. PKI’s stronger margin profile (EBITDA margin ~35%) and better leverage (net leverage ~1.5x) is reflected in the current 10-year spread differential, but it does not account for the additional steepness. Given that STE’s deal priced with a 35 bp 10s/30s curve while PKI’s priced at 30 bp, the STE 30-year bonds have upside potential of 7-10 bp.

Exhibit 1. BBB Healthcare 10/30s Curve

Source: Bloomberg TRACE; Amherst Pierpont Securities

Recurring Revenue Supports Revenue and EBITDA Stability

STE provides sterilization products and services to a host of customers including hospitals and health care centers which tend to be recurring in nature. Products such as chemical sterilizers and washers as well as services like microbial reduction of medical devices keep STE’s recurring revenue percentage in the 70%-80% range. In fact, STE’s Applied Sterilization Technologies (AST) business, which represents 20% of the company’s top line, is a contracted business with the majority of its customers in three-to-five year contracts with a very high renewal rate, as the business is highly regulated and STE is a leading player. Customers in this unit include healthcare product manufacturers and life science companies. While STE posted 1% organic (ex fx) growth in its last fiscal quarter, AST witnessed strong double digit revenue growth, largely fueled by COVID related demand of single-use products including COVID testing materials and components used in vaccine manufacturing and packaging. While demand has increased due to the pandemic, STE’s core medical device customers have also been showing steady demand which is expected to continue post pandemic.

Use of Equity to Fund Acquisition a Positive for Ratings

STE announced the acquisition of Cantel Medical Corporation for $4.6 billion earlier this year. While the deal came close on the heels of its acquisition of Key Surgical LLC, that acquisition was much smaller ($850 million).  Furthermore, management plans to fund the majority of Cantel acquisition with equity.  We note that STE will use $2.9 billion of equity to help fund the purchase as well as cash on hand and the $1.35 billion they just raised in the debt market. Management’s willingness to use equity to help fund the acquisition resonated well with the rating agencies as they all affirmed the ratings with a stable outlook subsequent to the announcement. Additionally, net leverage is only expected to increase to the 3.0x area but is forecast to be reduced back to management’s target range of 2.0x-2.5x within 12 to 24 months post close. The deal is expected to close by the end of June 2021. Management has noted that they do not plan on repurchasing shares or participating in significant M&A activity until it returns to its leverage target.

EBITDA Margin Growth Expected to Continue

STE has been posting EBITDA margin growth on an annual basis since 2014. Over that time period, margins have grown from 18.3% to approximately 25.7%. Street estimates are looking for the EBITDA margin to be up over 350bps in fiscal 2021, to the 29% area. With the acquisition of Cantel, STE is expecting to tap into cost synergies primarily through redundant public company and back-office overhead, as well as product manufacturing and service operations. STE believes it can capture roughly $110 million of cost synergies within the first four years post combination, with roughly 50% of the total expected in the first two years. Synergies will further add to margin growth. That said, consensus estimates have STE’s EBITDA margin 200 bp higher than PKI’s by fiscal 2022.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

Important disclaimers for clients in the EU and UK

This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.

This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.

This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.

This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.

The Library

Search Articles