Driven by increasing trade, greater environmental and health and safety regulation, and the trend towards outsourcing, the global market for product testing and inspection services is expanding at around 10% a year. And this mid-cap company has been a clear beneficiary – but now it’s looking vulnerable:
Intertek (ITRK), upgraded to OUTPERFORM by CSFB
Through its testing, inspection and certification activities, Intertek helps customers across a variety of different industries (from consumer and white-goods manufacturers to petrochemical groups) to appraise the suitability of their products and raw materials against a wide range of regulatory and quality standards. It runs laboratories in more than 110 countries, employing over 17,000 staff around the world.
Intertek achieved organic top-line growth of 8.1% to £665m in 2006, delivering underlying operating profit margins of 15.4% (compared with 15.0% in 2005) and earnings per share of 42.3p. Indeed, its three main operations – accounting for 92% of turnover – saw like-for-like sales grow by 13.4%. However, the group was held back by its smallest unit, government services, which lost two major contracts with the Nigerian and Venezuelan authorities.
Undoubtedly, Intertek is a solid business, but at what price does the stock represent good value? Well, with an ongoing tail-wind of more than 10% GDP growth from China, demand should remain robust for its services. Nevertheless, I believe that the City’s estimates for 2007 revenues and earnings per share of £726m and 49p respectively this year, rising to £797m and 55p in 2008, are stretching it. The group is heavily exposed to the dollar, with around 80% of earnings generated from related currencies. So as the greenback sinks further against sterling – now at around $2.06 to the pound – results will be adversely affected.
I would value the shares on a p/e ratio of around 15 times 2007 estimates – representing a fair value of 735p – and reflecting the challenging environment for dollar-exposed UK businesses. At current levels, the stock trades at more than a 40% premium and looks vulnerable. I would recommend that shareholders take profits and then recycle the proceeds into other, more attractive, opportunities. If you need any further convincing, the finance director has sold over £1m worth of stock over the past year at prices from 767p to 893p.
Recommendation: TAKE PROFITS at £10.05
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments