Steris (NYSE:STE), in the business of sterilizing nearly everything, could stand to clean up its numbers, it seems. The company reported less than exciting fourth-quarter and year-end results last week. Full-year revenue growth clocked in at 3%, barely keeping pace with the historical inflation rate, while full-year net income was down 8% to $1.23 per diluted share. The drop in net income is due to a higher overall tax rate, which isn't expected to improve much in the coming year.
While these facts seem pretty bleak, consider this: Much of the company's reported 3% yearly growth didn't come from the underlying business (providing innovative solutions in infection prevention, decontamination, and health science technologies), but from recent acquisitions.
When a company uses its cash flow to buy growth, that cash obviously can't be returned to shareholders. Therefore, in calculating the value for the shares, one can't simply look at the current growth rate; the contribution of acquisitions must be factored in, too. Sure, the company could keep buying its growth, but this reduces the yearly cash flow available to owners, and it's this cash flow, which -- when discounted to present value -- gives shares of Steris their value.
So how did Steris do after factoring out acquisitions? Well, the company reported Q4 revenue growth of almost 7%. However, after the acquisitions are factored out, fourth-quarter revenue growth drops to under 3%. If acquired revenue is factored out of full-year revenues, the 2005 revenue growth rate is even less than the reported 3%.
Since the company's overall business is showing so little growth, management has reaffirmed that it's looking to divest some assets in Steris' most unprofitable division, LifeSciences, which posted a $15 million loss this year. But shareholders should demand more. With large competitors like 3M (NYSE:MMM) and Johnson & Johnson (NYSE:JNJ), it just isn't good business to adopt a strategy you might call "jack of all trades, but master of none."
Steris management might do well to imitate former General Electric CEO Jack Welch and his "No. 1 or No. 2" strategy. (Welch wanted GE to be the No. 1 or No. 2 player in all of its market segments.) This forced the company to either fix, sell, or close any divisions that didn't fit or perform properly, boosting returns on invested capital and increasing GE's overall profitability.
While Steris may not have markets in which it is No. 1 or No. 2 in terms of market share, it certainly has divisions that are much more profitable and competitive than others.
But investors may not want to cross their fingers waiting. This strategy would almost certainly knock down the stock price in the short run, as the company's weaker divisions were sold for peanuts while year-over-year growth comparisons suffered. Management would also have to give up the thrill of the acquisition and the corresponding revenue boosts that support the stock price.
But, as it is now, Steris is not well-positioned to deliver shareholder value. With questionably priced acquisitions, very little real business growth, and several sub-par operating divisions, Steris needs to disinfect something, alright, and it has nothing to do with microbiology.
Fool contributor Matt Thurmond doesn't own stock in any of the companies mentioned in this article.
