• Although we expect U.S.-based Sotera Health Holdings LLC ended 2023 with S&P Global Ratings-adjusted (gross) leverage modestly above 5x, which is elevated for the rating, we expect leverage to decline below 5x in 2024 and to generally remain below that level thereafter.
• The elevated leverage primarily relates to $443 million of legal settlements in Illinois and Georgia in 2023 relating to environmental issues. We expect the company to be able to resolve the litigation still outstanding with its substantial cash balances, of nearly $250 million.
• We expect mid-single-digit percentage revenue and EBITDA growth in 2023, despite softer volumes than expected in its laboratory and sterilization services business lines, due to customer destocking.
• We affirmed our 'BB-' issuer credit and issue-level ratings on Sotera. The outlook remains stable.
• The stable outlook reflects our expectation that leverage will decline below 5x in 2024 and generally remain below that level thereafter, that cash on the balance sheet will be sufficient to cover remaining litigation, and that the company will continue to generate revenue growth, maintain very strong EBITDA margins, and generate significant free cash flow.

NEW YORK (S&P Global Ratings) Feb. 9, 2024--S&P Global Ratings today took the rating actions listed above.

Although legal settlement costs in 2023 raised S&P Global Ratings-adjusted debt leverage above the 4x-5x range consistent with the rating, we expect leverage will decline below 5x in 2024 and generally remain below that level thereafter.   Sotera took on additional debt in 2023 to fund a $408 million settlement with over 99% of the 882 claimants relating to alleged environmental issues from a facility in Willowbrook, Ill. The company also entered into an agreement to settle with 79 plaintiffs in Gwinnett and Cobb Counties, Ga. for $35 million, in October 2023. This led to an uptick in leverage.

The bulk of the outstanding litigation, relates to 220 personal injury claims and 365 property cases, still in the early phases of litigation in Cobb County, Ga.. We understand that legal standards appear to be more favorable for the company in that jurisdiction, as demonstrated by a cap on punitive damages and the requirement for dual causation to be established before awarding damages. The company also faces some cases in Santa Teresa, N.M.

Although there is substantial uncertainty regarding the outcomes of ongoing litigation, our base case expectation is that the company will be able to address any remaining legal settlements from its substantial cash balance of about $245 million as of September 2023.

We expect mid-single-digit revenue and EBITDA growth in 2023, which is lower than expected.   The company experienced softer volumes than expected in its laboratory and sterilization services business lines, due to customer destocking. In addition, the harvesting schedule of its Nordion business segment was back-end loaded in 2023, with half of Nordion's annual revenues expected to occur in the fourth quarter. Thus, we expect adjusted gross leverage for 2023 in the low-5x area, a material improvement from 5.5x in the third quarter (net leverage was 4.9x). We expect Sotera will continue deleveraging organically through low- to mid- single-digit percentage EBITDA growth in 2024.

Sotera's competitive position is supported by strong underlying demand for its services, and high barriers to competition.   The fact that there is more Cobalt-60 demand than Nordion is able to meet each year allows the company to largely avoid margin contraction as it can pass cost increases through to its customers. Strong customer demand for contract sterilization services have enabled both its Sterigenics business segment and competitor STERIS PLC's AST segment to expand at healthy growth rates across multiple modalities without sacrificing margins. We believe recent volume softness is mostly attributable to customer inventory reductions and we expect that to normalize in 2024.

Although the decline in pandemic-related demand has led to margin contraction for its Nelson Labs business segment, we expect its 2023 revenues to be flat with 2022 and margins to still be above 30%. Notably, revenues for the segment are about 15% higher than in 2019, prior to the pandemic.

The high ownership interest by financial sponsors constrains our view of financial policy.   We believe that financial sponsors are likely to reduce their stake in the company over coming years, which together with deleveraging could support a higher rating. Notably, when we determine that the company is no longer effectively controlled by financial sponsor owners, likely when their ownership interests decline below 40%, we expect to shift our primary focus to net debt rather than gross debt, as we do today.

The company appears well positioned to address evolving regulations across its businesses.   Although the European Union's new medical device regulations continue to be delayed, we expect it will provide a tailwind to Nelson Lab's demand within the next two to three years.

In the U.S., we expect the Environmental Protection Agency to finalize its National Emission Standards for Hazardous Air Pollutants (NESHAP) regulations for ethylene oxide (EtO) within the next few months. We expect the EPA's final regulations and those of California's Proposed Amended Rule 1405 will not be overly burdensome for Sterigenics. In fact, we expect it may help further differentiate Sotera and STERIS from the smaller, less well-resourced providers of sterilization services.

Within the Nordion business, the company has successfully navigated a challenging regulatory environment with minimal disruptions from its Russian-sourced Cobalt-60 despite nearly two years of substantial sanctions on Russia from the U.S. and E.U. Given both the diversity of its Co-60 sources and the timing of its harvesting schedule, less than 3% of Sotera's 2023 revenue was at risk to disruptions in Russian sourcing. We expect similarly low levels of revenue will be at risk in 2024.

The stable outlook reflects our expectation that leverage will decline below 5x in 2024 and generally remain below that level thereafter, that cash on the balance sheet will be sufficient to cover remaining litigation, and that the company will continue to generate revenue growth, maintain very strong EBITDA margins, and generate significant free cash flow.

We could lower the rating if we expect Sotera's S&P Global Ratings-adjusted leverage will be sustained above 5x.

Such a scenario is possible if:

• Sterilization and testing demand weakens,
• The company faces additional legal or environmental setbacks that increase legal liabilities or weaken operational or financial performance, or
• The company pursues significant debt-financed acquisitions.

Although unlikely within the next 12 months, we could upgrade Sotera if leverage declines below 4x, providing we expect it will sustain leverage at that level. In addition, we would need to see a material decrease in financial sponsor ownership (to about 40% or less) and further advances in the resolution of EtO litigation matters.

Social factors are a negative consideration in our rating of Sotera Health Holdings LLC. The company spent over $408 million and $35 million in 2023 to settle litigation in Illinois and Georgia, respectively, relating to allegations that EtO emissions contributed to health issues. We see risk of incremental legal costs, primarily relating to cases in Georgia and New Mexico and we expect regulators to more enact more aggressive regulation on EtO emissions, which may burden the company with incremental costs.

Governance factors are also a moderately negative consideration. Our assessment of the company's financial policies reflects its ownership by financial sponsors including corporate decision-making that prioritizes the interests of its controlling owners. This is consistent with our view of other rated entities controlled by private-equity sponsors. This assessment reflects private-equity owners' generally having finite holding periods and a focus on maximizing shareholder returns, notwithstanding the partial initial public offering of Sotera in 2020.

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