Shares digital

Testing company should be solid performer

by Dan Coatsworth

Intertek (ITRK) 955.5p, Stop loss 764.5p

Shares summary

A solid performer in safe markets. Investors seeking a haven in volatile equity markets would do well to consider Intertek.

Business:

Testing services

Vital stats:

Market value: £1.5 billion

Historic PE: 19.1

Prospective PE 2008: 16.0

Prospective PE 2009: 14.4

Sector PE : 12.7

1-month relative strength: +0.5%

1-year relative strength: +17.2%

Yield: 2.4%

Spread: 0.3%

The strengthening of the dollar against sterling is good news for Intertek as it generates over half of its revenue in the currency. It is another attribute in favour of buying shares in the testing company, which has proved to be one of the more resilient stocks on the market. The firm’s growth is driven by legislation; it has diverse geographical and industry exposure; and is a key player in a sector undergoing consolidation amid takeover interest from rivals and private equity. The shares are not cheap but in volatile markets it can be worth paying extra for the best.

Testing companies may not sound attractive investments but they operate in fairly safe markets. Consumers demand more information about the food they buy, for example, so packaging now shows more detail about the contents and ingredient origins. Testing firms verify the product contains what the packaging says it does. When parents buy a Happy Meal from McDonald’s, they want to be sure the toy that comes with the burger and chips does not have components that could harm their children. Intertek tests these products.

Even governments call upon testing groups to check whether imports comply with safety and quality standards. The market is unlikely to recede as most testing work is non-discretionary spending.

The global testing market is worth an estimated e50 billion a year. It has benefited from structural growth, driven by the commodity boom, more outsourcing to testing specialists and new legislation, leading organic revenue growth of around 10%. Morgan Stanley says this may slip back to 7% but believes the sector should remain defensive with wage inflation concerns more than offset by price increases.

Intertek is forecast to see organic growth ease back from the 11.3% compound rate seen between 2004 and 2007 to 8% in 2009. Profit margins are set to improve in its oil, chemicals and agriculture operation. It inspects cargo and runs laboratory tests to confirm the quality and quantity or products from energy, petroleum, chemical and agricultural companies. In the first half of 2008, revenue increased by 17.2% to £143.8 million and operating profit by 34.2% to £15.3 million at constant exchange rates.

The consumer goods division is benefiting from the rise in products coming out of China, which need checking for quality and safety. The loss of a key contract in 2007 has hurt government services income. Some margin decline has been noted in the commercial and electrical arm on slower growth in Europe and investment in new testing technology. However, the company reckons this investment will soon pay off.

Smaller rival Inspicio was taken private in December 2007 by a private equity-backed management buyout, giving investors at the 2005 flotation a 125% return on their money. Larger rival SGS has long been talked up as a potential bidder for Intertek. Seymour Pierce analyst Kevin Lapwood reckons Intertek does not deserve to trade at a discount to SGS, currently around 15%. He says the gap is ‘unjustified’. Intertek, however, trades at a 18% premium to the UK-quoted support services sector, in recognition of its solid earnings and diverse growth potential.

Shares in the firm have traded between around £9 and £10.50 since March. Intertek suffered at the hands of Morgan Stanley in August when it downgraded the stock from ‘buy’ to ‘equal-weight’ on concerns about a potential slowdown in trade. Shares believes the investment bank is being overly cautious and underestimating the resilience of the sector. This is a stock suitable for long-term investors seeking stability in their holdings, rather than quick-term gains.