Providing assurance, testing, inspection and certification services, Intertek (ITRK) may not undertake the world’s most exciting activities. But it plays a vital role in the global economy, scrutinising not just the quality and safety of many of the goods and services we use everyday, but the entire supply chain behind them. From children’s toys to construction, the group’s ‘total quality assurance’ expertise enables companies to ensure they comply with an ever-increasing regulatory burden. Its mission-critical nature is reflected in steady sales and margin progress – adjusted operating profit growth between 2014 and 2018 was just shy of 50 per cent.
Untapped outsourcing potential
Some cyclical exposure
Estimating the global quality assurance market is worth around $250bn, Intertek believes 80 per cent of the work is still conducted in-house. With governments, consumers and investors increasingly focusing on corporate safety, quality and sustainability, long-term trends should push more companies to outsource their end-to-end quality assurance needs. Rising global and regional trade involves abiding by different standards across geographies while globalisation has increased the complexity and supply chain risk.
Over three-quarters of overall adjusted operating profit comes from ensuring physical components, products and their supply chains meet safety and performance standards. With innovation driving shorter product life cycles and e-commerce continuing to flourish, more products means more to check. The first half of 2019 saw adjusted operating profit in the products division rise by 6 per cent at constant currencies to £185m, on the back of a 21.3 per cent margin.
Despite wider US-China trade tensions, adjusted operating profit in the trade segment (17 per cent of the total) rose by 6.8 per cent at constant currencies to £44.2m. Localised momentum may be acting as a counterbalance to the uncertain macroeconomic environment, as the domestic Chinese market (which represents around 25 per cent of operations in China) is said to be growing at double digits. Amid fears of a global economic slowdown, it is somewhat reassuring that Intertek continued to grow during the financial crisis.
Historically, the worst cyclical exposure has come from the oil and gas sector. An oil price slump triggered a £577m non-cash impairment charge in 2015, pushing the group to a £308m statutory pre-tax loss. This vulnerability has been tempered, with the proportion of adjusted operating profit derived from the resources division falling from 10 per cent in 2015 to 6 per cent in the first half of 2019. With improving momentum and 3.5 per cent organic revenue growth exceeding analyst expectations, the rise of renewable energy should bring further growth and diversification.
Exploiting a fragmented market, Intertek has relied on acquisitions to help drive top-line growth. An average return on invested capital of 22.7 per cent between 2015 and 2018 suggests a disciplined approach to capital allocation, but it’s worth noting the consistent exclusion of restructuring, acquisition and amortisation costs, which flatters the underlying numbers. Although no purchases were made in the first half of this year, £389m was spent on four acquisitions in 2018 (net of cash and debt) compared with £113m invested in organic growth. The company aims to improve margins as well as growth prospects with its frequent bolt-ons, and the full-year underlying operating margin has risen in increments from 15.5 per cent to 17.2 per cent over the past five years.
First-half currency-adjusted sales growth of 4.9 per cent included organic growth of 3 per cent, with progress from all three divisions. A new ‘total sustainability assurance’ initiative could underpin future organic growth and also open up cross-selling opportunities. Providing ‘corporate sustainability certification’, this audit service verifies companies’ environmental, social and governance credentials against Intertek’s criteria. While some might question the need for yet another industry standard, analysts at Deutsche Bank consider a framework through which to earn a sustainability qualification a key differentiator.
Excluding £256m in lease liabilities, net debt stood at £826m at the end of the first half. At 1.4 times adjusted cash profits (Ebitda), this is below the target range of 1.5 to 2.0 times, which leaves plenty of scope for further acquisitions. Without deals, Deutsche Bank forecasts that net debt will fall to £624m by the year-end. Meanwhile, free cash flow generation remains strong, with £94.1m recorded in the six months to 30 June.
|ORD PRICE:||5,250p||MARKET VALUE:||£8.4bn|
|FORWARD DIVIDEND YIELD:||2.1%||FORWARD PE RATIO:||24|
|NET ASSET VALUE:||549p*||NET DEBT:||118%|
|Year to 31 Dec||Turnover (£bn)||Pre-tax profit (£m)||Earnings per share (p)||Dividend per share (p)|
|Normal market size:||300|
|*Includes intangible assets of £1.2bn, or 739p a share|
|**Deutsche Bank forecasts|