Over the past few years the £50bn global product testing and inspection services market has been expanding at around 10% a year, driven by growing global trade, greater environmental, health and safety regulation, and the trend towards outsourcing. One beneficiary has been Intertek. Via its testing, inspection and certification activities, the company helps customers across a variety of different industries to appraise their goods and raw materials against a wide range of regulatory and quality specifications. For example, Intertek checks that gifts within McDonalds’ Happy Meals do not contain traces of lead that could harm children.
Intertek (LSE:ITRK), rated a BUY by Jefferies
The group has also been boosted by the US mandating that all imported toys have to be examined after a series of Chinese-made goods were recalled; and by the ailing pound, as the firm generates over 80% of turnover in non-sterling currencies. City analysts expect this to continue, delivering 2009 sales and underlying earnings per share of £1.2bn and 70.7p respectively, rising to £1.3bn and 74.6p in 2010.
But this optimism looks misplaced. Global trade will be flat at best this year, which will hit Intertek’s consumer-related activities, especially in the automotive sector. The firm’s success also depends on the West’s ongoing thirst for everything Chinese. Yet official data show that Chinese exports fell 26% in February. On top of this deceleration in its volume-linked operations (30% of revenues), there’s the inevitable shrinkage of new product launches as corporate research and development budgets are trimmed. This is important as juicy margins are derived from pre-approval testing. Intertek also carries significant litigation risk, in that if it fails to perform its contracted services correctly and a harmful product goes undetected, this could cause serious financial loss and also damage the group’s reputation.
Finally, the valuation looks stretched. Given that its 16.4% profit margins could come under attack, I would rate the stock on an eight times EBITA multiple which, after deducting the £308m debt load, generates an inherent worth of around 660p a share. All told, if the economy sinks, then so will Intertek’s heady stock.
Recommendation: TAKE PROFITS at £9.22
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments