With Brexit looming and the real possibility of leaving the EU with no trade deal in place, quality assurance company Intertek (ITRK) may potentially be in a position to make hay.

There may be additional regulatory regimes to satisfy once the UK leaves the EU. That could create additional work for the FTSE 100 business as companies seek to meet these new requirements.

While that is a potential earnings boost, it isn’t the main reason why investors have been eager to own the stock. Intertek’s core investment appeal lies in its strong market position for global quality assurance.

We live in a nation that is producing more and more goods and all these items have to be checked for safety reasons and to verify their contents match their description.

Intertek’s seal of approval can be found on toys, electrical appliances and even clothes. It is the largest tester of consumer products in the world and has over 1,000 laboratories, with over 40,000 employees in 100 countries.

Other industries in which it validates the specifications, value and safety of materials include oil, construction, engineering, food and healthcare.

And Intertek works with governments, customs and national standards organisations to improve the compliance of imports with safety standards in order to help them protect import duty revenues and keep international supply chains running smoothly.

A MARKET LED BY THREE

The testing, inspection and certification market is dominated by three players: Intertek, Switzerland’s SGS and France’s Bureau Veritas.

Being part of an elite group in a vital industry combined with recurring revenue that keeps climbing has resulted in Intertek’s shares trading on high multiples.

Negative market reaction to half year results on 7 August has seen the share price subsequently fall by 11% to £52.16 and lowered the valuation. Intertek now trades on 24.8 times forecast earnings for 2019; admittedly that is still a premium rating and perhaps one that is too rich for many investors to stomach when looking at the pace of future growth.

Analysts at stockbroker Numis presently expects it to deliver £2.807bn revenue this year (2017: £2.769bn), rising to £2.983bn in 2020. You could argue that is slow and steady growth, but you also have to consider that Intertek is exposed to cyclical industries and a slowdown in global economic activity would certainly be bad for its earnings.

UNDERSTANDING RECENT SHARE PRICE WEAKNESS

The most recent share price sell-off was triggered by Intertek missing market expectations for its half year results at the earnings per share level with analysts also closely scrutinising organic growth and margin.

Yet a broader look at the share price performance would suggest the most recent set-back is just a small blip in what has otherwise been a solid show.

Since Andre Lacroix became chief executive in 2015, the company’s share price has appreciated by around 100%. That is phenomenal growth by anyone’s standard and keeping up that pace is going to be a tall order.

Indeed, in April, stockbroker Shore Capital posed the question: is this the end of an ‘exceptional era’ for Intertek? It expressed concerns about the source of future upside value creation, saying it was hard to predict M&A and that the company’s emerging value from its assurance arm was unlikely to be a catalyst to keep the share price going in the short term.

HOW A NEW CEO TRIGGERED A SHARE PRICE RE-RATING

The driving force behind the growth since Lacroix took the top job was this move to total quality assurance as well as TIC which he dubs ATIC (assurance, testing, inspection and certification).

In 2016, Intertek released a strategy update outlining the change in focus and the company’s acquisition of US-based Alchemy in August this year is a continuation of the desire for this type of high margin business.

Alchemy is a provider of software as a service (SaaS) people assurance solutions for the food industry. Intertek said that the $480m deal would help with the complex supply chain issues in which employees are key. The business helps identify and mitigate the risks in its clients’ supply and distribution chains.

Intertek says it will be able to use Alchemy’s SaaS platform across all industries with a ‘large deskless’ workforce. The deal will be earnings accretive and bolster Intertek’s position in the all-important food industry.

Steve Woolf, an analyst at broker Numis, says: ‘We believe that Intertek is a quality company that is well-positioned in a structural growth market. It continues to deliver high returns, but at the current level, the valuation appears up with events.’

THE PRICE IS WRONG

There’s no doubt that Intertek has a commanding position in a sector that is vital for global trade. However, on its current valuation we see no great motivation to go out and snap up its shares.

Analysts seem to concur – only two analysts have a ‘buy’ rating on the stock out of a total of 16 covering Intertek. The majority (10) are sitting on the fence with a ‘hold’ rating.

Fundamentally Intertek is a decent business yet it is hard to justify paying the current price for the stock. We suggest you start building a list of stocks to buy should there be a market correction and put Intertek at the top. It is worth buying but only on a much lower rating. (DS)

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