Steris Plc (STE)

Steris is a market leader in disinfection and sterilization equipment; consumables and services for hospitals and surgery centers; and for medical device, life science, and healthcare enterprises. The company was founded in Ohio in 1985, initially went public in 1992, and is now domiciled in Ireland and headquartered in Mentor, Ohio. Approximately 70% of the $4.6 billion in March 2022 fiscal year revenues derived from the U.S. The U.K. and other international regions accounted for the remaining 10% and 20% of revenues, respectively.

Steris controls about a 50% share of U.S. hospital and ambulatory operating room facilities, including operating tables, lights, and infection prevention and control equipment. Overall, the company’s business reflects a 75% / 25% recurring revenue / capital equipment operating model and thus it experiences limited cyclicality. The bulk of revenues derives from the healthcare and pharmaceutical industries; no single client accounts for more than 10% of revenues. Steris’ talented management team has completed a number of attractive merger & acquisition activities over the years. Given the company’s strong financial foundation and growing profitability, we expect additional M&A activity in the years ahead. Steris is a dominant force in medical device sterilization globally, reportedly sterilizing about a third of all medical devices in the world for pharmaceutical and life sciences companies.

The Partnership initially purchased Steris during the March 2020 COVID crisis, when the S&P 500 plummeted 34% in three weeks. Steris’ shares had declined about 25% to under $120 per share, and we purchased a sizeable position. We have owned and researched other players in the industry since the early 1980s. Since purchase, Steris has performed relatively well and the stock closed the quarter at $206, or about 72% above where it was purchased a little more than 27 months ago. Steris is a very strong company with a rising dividend and fairly predictable and promising financial fundamentals. The $1.91 dividend yields just 0.9%, but it has been raised 13% annually during the past ten years and should experience continued strong growth.
Steris reports revenues in four business segments: Healthcare, Applied Sterilization Technology, Life Sciences, and Dental. It offers a full suite of sterilization processes, from the sale of individual sterilizers and related equipment and services to the full outsourcing of sterilization requirements by customers to Steris-owned and operated plant sites, facilitated by long-term contracts. Steris benefits regardless of how hospitals or other clients manage their sterilization needs.

Figure IV – Steris steam sterilization for medical equipment

The Healthcare segment, 62% of FY 2022 total revenues, provides a comprehensive offering for healthcare providers globally. After capital equipment such as sterilizers and washers are sold, usually to major manufacturers of medical devices and healthcare consumables, customers are required to sign contracts with Steris for routine equipment service and sterilization of consumables for the life of the products. The capital equipment market is benefitting from a recovery after being muted during the first two years of the COVID pandemic, and by ongoing growth in ambulatory surgery centers. The Applied Sterilization Technology (AST) service segment, 19% of revenues, doesn’t manufacture any products and generates thehighest operating margins in the business, reflecting the fact that 80% of the segment’s business is managed through long-term contracts. High upfront costs in the construction of large-scale, complex medical sterilization plants, owned and managed by Steris, are rewarded through attractive long-term contracts with clients, who benefit from scale and Steris’ technical expertise. Trucks bring the products to the plant site for sterile processing, then deliver the sterilized and packaged products back to the manufacturer or end user. Sterilizers and washers are often designed for specific medical devices. Reliability is critical due to the high cost of down time for the medical device manufacturer or the possible need to change processing equipment and therefore retrain workers. Steris presently has sixty U.S. contract sterilization plant sites, another ten in the U.K. and thirty at other international locations. AST’s growth is also benefitting from price increases, share gains, and growing medical device volumes. The Life Sciences segment, 11% of revenues, has a similar business model, except revenues are generated by life science versus healthcare companies. The Dental segment, 8% of revenues, was acquired along with Cantel Medical in 2021. Steris’ strong reputation for quality and reliability facilitates sales of instruments, infection prevention consumables, and instrument management systems to dental practitioners and dental schools, a new segment for growth.

Management recently noted that demand has largely normalized following the COVID pandemic, but that labor shortages and parts scarcity are limiting ability to convert the sizeable healthcare backlog into revenues, possibly penalizing segment revenues by 3% to 5% in fiscal 2023. With the Cantel Medical acquisition, Steris has become the new global leader in international markets, combining Steris’ strong presence in the U.S. with a growing solid footprint across Europe, and an opportunity to improve the position significantly in the emerging markets of Asia and Latin America. We forecast overall revenue and operating income growth in the high single to low double digits along with significant restructuring benefits from the integration of Cantel Medical and Key Surgical during the next several years. Steris is valued at roughly 21-times calendar 2023 EPS and we believe the stock offers compelling value.

Nordson Corporation (NDSN)

Nordson Corp. (NDSN) is a recent addition to the portfolio. The company is an investment in two secular growth themes: factory automation and minimally invasive cardiovascular surgery. Nordson’s origin dates to the founding of the U.S. Automatic Company in 1909. In 1935, under the direction of Walter G. Nord, the company shifted production to high-precision parts critical for U.S. defense needs during World War II. Nord’s sons acquired patents in 1954 for the “hot airless” spraying of paint and other coating materials, and this marked the beginning of the Nordson name. The Nord family still owns 9.1% of company shares. With $2.1 billion in revenues in 2021, Nordson has a diversified portfolio, both in terms of end markets and geographies. Its products are typically critical for customers such as Proctor & Gamble, Dupont, Honeywell, and Medtronic, and Nordson has leading share across a number of product categories.

Nordson’s business is organized in three business segments: Industrial Precision Solutions ($1.2 billion revenues), Medical and Fluid Solutions ($0.6 billion revenues), and Advanced Technology Solutions ($0.5 billion revenues). Nordson’s precision injection and coating systems dominate the automated manufacture of electronics, washing machines, diapers, cartons, and other consumer products. Its counting, testing, and x-ray equipment ensure that customers’ products meet high quality standards. The company’s medical device technology yields highly engineered tubing, catheters, and balloons that last a lifetime in patients’ bodies. Nordson recently restructured its reporting segments to create the Medical and Fluid Solutions division, which is leveraged to an aging and increasingly long-lived population, and is the fastest growing part of the company.

CEO Sundaram “Naga” Nagarajan joined Nordson in 2019. Prior to this, he spent 23 years at Illinois Tool Works, an industrial manufacturer known for constant improvement and superior profitability. Nagarajan and the management team lead the company utilizing NBS Next (Nordson Business System), which provides a set of business tools for evaluating investments and enhancing business productivity. Corporate objectives include growing revenues organically at 4% to 5% annually based on outperforming the end markets by 1% to 2%. NBS emphasizes strong operating execution, and managers are incented to improve margins and financial returns. Nagarajan has successfully expanded Nordson’s position in semiconductor manufacturing, and the company’s semiconductor bond testers, curing ovens, plasma treatment technology, and wafer inspection systems should gain outsized share of U.S. investment in domestic semiconductor manufacturing.

Figure V - Nordson Asymtek combines conformal coating and inspection for semiconductor chips into one automated system

We believe Nordson is a superior company financially. Recurring revenues are sizable at 55% of total, and are derived from parts and service tied to the constant wear-and-tear of components such as nozzles, filters, hoses, and valves. While still cyclical, Nordson is more consistent and predictable than many industrials. Over the past ten years, revenues have compounded at 6.7%—half from internal growth and half from acquired companies—while free cash flow and earnings have grown at 8.4% and 9.1% rates, respectively. Even as the company has assimilated new adjacencies and competencies, business efficiency has improved, with operating profit margins at 26% and free cash flow margins at 21.5% in 2021. Nordson is a global company, with 42% of revenue in the U.S., 25% in Europe, and 33% in Asia. This reduces regional volatility and harnesses access to fast-growing emerging markets.

Warren Buffet once said that it is “far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Following its decline from a high of $270 early in the year to recent prices around $200, Nordson stock now trades at over 22-times 2022 company EPS guidance and 26-times 2022 company free cash flow guidance. This is indeed a fair price for a wonderful company. We hope to build the position at attractive prices as market volatility continues over the next several months.