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Intertek should thrive in testing times

'Unprecedented levels of risk' spell opportunity for the quality assurance specialist
Intertek should thrive in testing times

Some companies offer so many services that it’s easy to lose track. Intertek (ITRK) falls into this category. The quality assurance specialist started life 130 years ago, certifying grain cargoes and ensuring the safety of Thomas Edison’s inventions. Now, it tests everything from children’s toys and power stations to electric cars and cosmetics. As the world becomes increasingly regulated, however, the group’s enormous footprint and eclectic customer base are worth paying attention to.

Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Regulation on the rise 
  • Strong cash flow
  • Imposing market position
  • Diverse client base
Bear points
  • Struggling resources division 
  • Looming debt deadline

This doesn't mean the business defies economic gravity. During the pandemic, mass disruption to global supply chains and retail operations hit Intertek’s performance, and reported pre-tax profit fell by a quarter in 2020 to £344mn, before rebounding to £413mn in 2021. The knock also caused its dividend to plateau at 105.8p per share, after a decade of increases. In the wake of Covid-19, however, growth is expected to accelerate: analysts think sales will exceed £3bn by December 2022, while adjusted pre-tax earnings are due to rise to £489mn (see table below). 

These projections are underpinned by a convincing narrative. While lots of Intertek’s clients are being buffeted by inflation, labour shortages, and logistical woes, the group itself looks relatively well protected. For starters, Intertek has a big enough client base – 400,000 and counting – to allow for some to fall by the wayside. More critically, few companies can afford to scrimp on the safety of their products; they need to comply with regulations. For proof, one need only look back to the 2008-09 global recession, when demand proved robust and meant Intertek's operating profits carried on growing. 

Of even greater importance, however, is Intertek’s focus on supply chains. In 2015, the group added ‘assurance’ to its testing, inspection and certification services. While the term is vague, the company promises to improve businesses’ “sourcing, production and logistics activities”, and get their supply chains “back to normal”. Much like logistics companies, therefore, Intertek looks set to benefit from supply chain turbulence, as more businesses seek external help.

Longer-term trends should also fuel growth. Regulation relating to environmental, social and governance (ESG) issues is on the rise, and companies need to show they meet a broad range of quality standards. Increasingly, they are also expected to demonstrate an understanding of the risks and footprints throughout their supply chain, and issues associated with products following their sale. 

This isn’t always straightforward, and demands significant infrastructure and specialist skills. Intertek has these in spades. Management estimates that just $50bn of the $250bn assurance, testing, inspection and certification market is currently outsourced, meaning there are plenty of opportunities for growth. 

 

Quality Products 

Despite the scope of the business, Intertek is divided into just three sections: products, trade, and resources. Of these, products – which looks at physical components and products for retailers and manufacturers – is easily the largest, generating around two-thirds of total revenue. It also has the roomiest adjusted profit margin (22.8 per cent) and adjusted operating profit is growing strongly, up 14 per cent year on year. 

Going forward, the division should benefit from ever more products hitting the market, the acceleration of online shopping, and demand for sustainable items. It’s also worth noting that around a fifth of Intertek’s revenue comes from China. While this comes with its own issues – this week, in an otherwise positive trading update, the group said ongoing lockdown restrictions in the Middle Kingdom could mean disruption until July – it means Intertek is exposed to Beijing’s push toward higher-specification production and technological output.  

 

At the other end of the spectrum is the resources arm, which focuses on oil, gas, nuclear, and other types of power. Despite making up 16 per cent of 2021 sales, the division accounted for just 5 per cent of adjusted operating profit, after falling 22 per cent year on year. Its profit margin also contracted by 120 basis points to just 5 per cent. 

These aren’t great figures, but historic trends suggest there are grounds for optimism in the near term. In 2015, Intertek booked a £577mn impairment charge as a result of “challenging trading conditions in the global oil and gas industry”. In a similar vein, when oil prices plunged in 2020, Intertek’s resource’s arm saw revenue and profit tumble. Today, however, oil prices are again sky high and energy companies have turned into cash machines, meaning next year’s outlook could well be cheerier. 

 

Global reach 

Expansion is now back in focus – and here, Intertek has a good track record. Upon listing in 2002, the group had roughly 10,500 employees and 750 laboratories. It now has 1,000 laboratories and offices worldwide, with over 44,000 employees. It achieved this through both organic investment and a series of acquisitions, and the fact that return on capital employed has consistently exceeded 20 per cent suggests that it’s doing something right. 

Intertek made its biggest acquisition last year, spending over £450mn on SAI Global Assurance, a provider of assurance services based mainly in Australia. The goodwill arising from this acquisition, together with the purchase of a Brazilian food testing business, was £413mn. As a result, goodwill now represents almost 40 per cent of Intertek’s total assets, or double the value of its property, plant and equipment.

A preponderance of intangibles makes it difficult to gauge how much a company is actually worth, and goodwill is notoriously slippery. However, Intertek’s performance history is strong. Despite an abundance of acquisitions, its latest goodwill impairment dates back to 2017, and only came to £18.2mn. Meanwhile, SAI promises to bolster Intertek’s position in Australia, the US, Canada, the UK, and China.

Another aspect of Intertek’s balance sheet that needs monitoring is gearing. Last year’s acquisition spree caused net debt to surge from £420mn to £733mn. Although still comfortable at 1.1 times' Ebitda, almost half of the group’s total borrowings – amounting to £460mn – comes due within the year. Intertek is extremely cash generative, reporting over £400mn of free cash flow in 2021. However, the maturity profile of its borrowings will do little to improve the stagnant dividend situation, and drags its current ratio (the proportion of current assets to current liabilities, and a key measure of a company's ability to meet its short-term liabilities) to 0.76.

Any balance sheet weakness does little to undermine Intertek’s growth prospects however – or its current value. Over the past five years, the company’s average price to earnings (PE) ratio has stood at 25.7. After a difficult lockdown, though, its share price has taken a beating and its forward PE ratio now stands at a more reasonable 22.

No company is immune to macroeconomic pressures, as Intertek's pandemic showed. But the company looks poised to cash in on current difficulties, as well as long term trends. 

Last IC View: Buy, 5,318p, 1 March 2022

Company DetailsNameMkt CapPrice52-Wk Hi/Lo
Intertek (ITRK)£7.91bn4,899p5,968p / 4,703p
Size/DebtNAV per share*Net Cash / Debt(-)Net Debt / EbitdaOp Cash/ Ebitda
693p-£1.03bn1.6 x96%
ValuationFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)P/Sales
222.4%4.0%3.3
Quality/ GrowthEBIT MarginROCE5yr Sales CAGR5yr EPS CAGR
16.0%21.2%1.7%2.4%
Forecasts/ MomentumFwd EPS grth NTMFwd EPS grth STM3-mth Mom3-mth Fwd EPS change%
11%8%-5.1%2.8%
Year End 31 DecSales (£bn)Profit before tax (£mn)EPS (p)DPS (p)
20192.99475213106
20202.74368171106
20212.79431191106
f'cst 20223.07489216114
f'cst 20233.22527233122
chg (%)+5+8+8+7
Source: FactSet, adjusted PTP and EPS figures
NTM = Next 12 months
STM = Second 12 months (ie, one year from now)
*Includes intangible assets of £1.6bn, or 995p a share