Turkey of the week: solid but overpriced testing specialist
By
Paul Hill Sep 25, 2009
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One inevitable consequence of recessions is increasing protectionism, with political concerns relating to domestic job security over-riding global trade relations. So I wasn't surprised to hear the latest round of national self-interest kick off a fortnight ago, with America slapping a 35% tariff on tyres imported from China.
In response, Beijing threatened to block imports of American chickens and car parts. At this stage, there is no way of predicting whether these two partners will kiss and make-up, or whether it will escalate into a full-fledged trade war. But if the conflict deepens and results in further sanctions, then Intertek, a FTSE 100 constituent, would be affected.
Intertek is a leading international testing, inspection and certification specialist. It owns 270 laboratories worldwide. From these it helps customers across a variety of different industries, from consumer and white-goods manufacturers to petrochemicals, to appraise the suitability of their finished goods and raw materials against a wide range of regulatory and quality specifications.
Intertek (LSE: ITRK), tipped as a BUY by Bank of America
Protectionism and the resulting fall in trade isn't the only dark cloud on the horizon. Any protracted slump in the global economy would hit the firm's consumer-related activities (52% of profits). This division is currently doing extremely well, benefiting from new US toy-testing laws put in place following last year's product recall by Mattel, who had to withdraw 20 million items because of lead paint contamination.
But a double-dip recession and slow recovery will squeeze its 16.6% operating profit margins. Volume-linked operations (30% of sales) will decline and it will win less business from new product launches as corporate research and development budgets are trimmed. Indeed, fewer new car models have already put the brakes on income from its automotive customers.
In the light of this, the valuation looks stretched, particularly given recent disappointing updates from rivals SGS and Bureau Veritas. Consensus forecasts are for 2009 sales and underlying EPS of £1.2bn and 80.3p respectively, rising to £1.3bn and 85.7p in 2010 – hence putting the stock on racy p/e ratios of 15.4 and 14.5, while only paying a frugal 2% dividend. I would value the stock on eight times Ebita – assuming through-cycle margins of 15% – which, after deducting the £279m debt pile, generates an intrinsic value of 760p per share.
Intertek is a solid business that generates strong cash flows, owns attractive overseas assets and is partly cushioned against the recession due to regulatory requirements. But the shares are priced to perfection and so I would recommend taking profits and redeploying the funds in more compelling opportunities.
Recommendation: SELL at £12.44
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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