Quality assured: this FTSE stalwart has a new lease of life

In reality, Intertek isn’t brooding, particularly dramatic, or even aimed at consumers. The FTSE 100 company tests, inspects and certifies products before they go to market, and helps corporates streamline their supply chains on the side. It’s work that underpins swathes of the global economy but garners little attention. Few people care who has tested the toxins in their scented candle or the durability of their settee.

This is no bad thing: lesser-known businesses that enable flashier ones to function often make very attractive investments, and Intertek is no exception. 

Gear change 

For several years Intertek has claimed that the world is moving in its favour. “Unprecedented” levels of supply chain risk, complex regulatory landscapes, and sustainability goals would all boost demand for its services, management has long argued. Since Covid hit, though, its share price performance has been indifferent at best. 

Finally, however, global trends are translating into financial gains. Organic revenue growth reached 6.2 per cent in 2023, the highest level for a decade, and the shares have risen by a third in the past six months. 

Intertek’s industry and infrastructure division – which serves builders, miners and parts of the energy market – is benefiting from the Inflation Reduction Act in the US and green energy investments. Similarly, the corporate assurance arm – which focuses on supply chain improvements – has benefited from the logistical problems many companies experienced in 2022.

The consumer products business is under more pressure. Brands have been rationalising excess stock that built up during the pandemic, which has resulted in less product development and limited testing activity. As such, revenue at the division – which generates 28 per cent of Intertek’s sales and nearly half its profits – only edged up by 1.3 per cent on a like-for-like basis in 2023. 

As we move further into 2024, the group is starting to fire on all cylinders again. Chief executive André Lacroix told analysts in March that consumer products work was “turning a corner”, and this optimism has been echoed elsewhere. European rivals Bureau Veritas (FR:BVI) and SGS (CH:SGSN) have both reported better growth in this area, and analysts at UBS have argued that the falling average age of inventory suggests more products are being launched. 

Nonetheless, Intertek’s future looks bright – particularly after a 2023 in which trouble in its biggest business failed to deter group-wide progress. UBS is forecasting organic revenue growth of 5 to 8 per cent per year between now and 2028, compared with the 2 to 4 per cent achieved between 2014 and 2019, while Berenberg is similarly optimistic.

Intertek’s sunnier growth prospects imply good news for profitability. The company runs more than 1,000 laboratories and offices across 100 countries and employs 44,000 people, so fixed costs are high. Operational gearing should kick in, therefore, as demand increases.

Management is taking some proactive steps to chivvy the process along. Following the launch of a series of cost-cutting measures in 2022, savings hit £13mn last year, ahead of a £7mn to £8mn target. Another £10mn is expected this year, while other expenses have been tightly controlled; despite inflation, wages represent a smaller proportion of revenue than in 2019.

Intertek’s efforts are paying off. Its adjusted operating margin edged up to 16.6 per cent in 2023, and management said the group is on track to hit its pre-pandemic peak of 17.5 per cent in the medium term. 

China challenges

Intertek’s productivity push has not been entirely pain-free. It banked £22.4mn of one-off restructuring costs in 2023 and £27.4mn in 2022. On a statutory basis, therefore, its operating margin is less attractive at 14.6 per cent.

The bigger question around Intertek, however, is whether 2023’s organic growth rate is sustainable. Something that worries many investors is its exposure to China, given almost a fifth of its revenue stems from the country.

Lacroix has brushed off fears that companies are moving manufacturing away from China, saying export activities are up 35 per cent on 2019. There is no denying, however, that the Chinese consumer testing market is becoming saturated, and that growth rates in the region have been falling. According to Berenberg, growth declined from 10 per cent in the 2004-07 period to just 3 per cent in 2016-19. 

“We are bearish about how much growth even a strong Chinese export recovery could contribute to the testing, inspection and certification names in the future,” the bank concluded in a recent report. Should Donald Trump be re-elected as US president in November the situation could get even trickier, given his plans to impose steep blanket tariffs on Chinese trade.

Whether Intertek’s growth prospects are realistic clearly has a huge bearing on whether its valuation is reasonable.

As a quality large cap, it trades on a chunky forward price/earnings multiple of 21. This “very full valuation” has turned analysts at Shore Capital against the group. “With no substantive change to forecasts, but a c20 per cent share price outperformance to the market over the past three months, we move to sell,” they said in March.

Given the growth Intertek has already delivered, however, together with its margin improvements, its comments about the current year, and its obvious structural opportunities, this feels an overly pessimistic stance – particularly as the shares are still trading slightly below their historic average (see chart). And while today’s higher interest rate environment arguably justifies a lower relative multiple, this should be set against improved demand for Intertek’s services, industry trends and benefits accruing from greater scale.

There are other factors to weigh up, too. Intertek has the qualities of an attractive income stock, given its mature and cash-generative business model, having consistently converted over 120 per cent of its adjusted operating profits into operating cash flow. As a result, it has a good record of returning money to shareholders. Things are only improving in this regard, as it has just boosted its dividend payout ratio from 50 per cent of earnings to 65 per cent. 

At the same time, its balance sheet is getting stronger. Net debt (excluding lease liabilities, and therefore lower than the figure in the accompanying table) reduced by £127mn to £611mn in 2023, lowering the leverage ratio from 1.1 times to 0.8 times Ebitda (earnings before interest, tax, depreciation and amortisation). This suggests, further shareholder returns could be on the cards as well as more corporate activity.  

The testing, inspection and certification market is not one to set the pulse racing – and no advertising campaign can change that. However, this stolid blue-chip seems to be entering a new phase of growth, and investors are taking note. Indeed, the sector as a whole is gaining more attention, with US giant UL Solutions (US:ULS) making a successful debut on the New York Stock Exchange last month. As manufacturing stutters back to life, this recognition is well deserved.