This stock will continue beating the FTSE, but prepare for a bumpy ride

Sound fundamentals and an upbeat outlook make this one to back

Shares in FTSE 100 member Intertek have generated a 26pc capital return since this column first tipped them as a ‘buy’ in April 2023. This compares favourably with a rather humdrum 6pc gain for the large-cap index over the same period.
Our initial recommendation was largely based on an expectation that the provider of testing, assurance and inspection services would experience improved operating conditions. Indeed, the company’s financial performance is highly cyclical, in terms of it being very dependent on the world economy’s prospects, with demand for its services declining sharply during the pandemic.
While it has benefited from a solid global economic performance over recent years, investors may naturally wonder whether this will continue. Restrictive monetary policy in the US and in other developed economies is arguably yet to have its full impact on GDP growth and could prompt a slowdown before the effects of ongoing interest rate cuts are more widely felt. 
In such a scenario, Intertek’s share price could prove to be relatively volatile – especially since it trades on a rather rich price-to-earnings ratio of 22.9. This is substantially higher than the rating of around 19 that was present at the time of our original tip 18 months ago.
Although Questor would not be surprised if global GDP growth moderated to some degree in the short run and stock market volatility became elevated as a result, monetary policy easing is ultimately set to provide a further improvement in the company’s trading conditions. Indeed, the Federal Reserve is now expected to cut interest rates by a further two percentage points in just over two years. Given that the US is Intertek’s biggest single geographical market, accounting for 31pc of its sales in the most recent financial year, it should be a major beneficiary of a brisk pace of monetary policy easing.
The company’s latest half-year results show that it is currently performing relatively well. Like-for-like (LFL) sales growth was around 6pc, while operating profits moved over 14pc higher versus the same period of the previous year as a result of an increase in profit margins. 
At the operating level, the firm’s profit margin rose by 110 basis points to 15.9pc. This was aided by cost reductions that are set to continue in the second half of the year, and with the company expecting to produce a further 160 basis point rise in its operating profit margin alongside mid-single digit LFL sales growth over the medium term, its financial outlook is highly appealing. 
This helps to justify its rather generous market valuation, while solid fundamentals further enhance its long-term investment appeal. The company has a strong balance sheet, with net gearing amounting to 74pc at the end of the first half of its current financial year. In the six-month period, furthermore, net interest costs were amply covered nearly 12 times by operating profits. A sound financial position provides scope for the business to make further acquisitions in high-growth and high-margin segments following recent M&A activity.
Despite having only modest debt levels, the company has been able to generate high returns for shareholders. In its latest financial year, for example, return on equity was 29pc. Alongside its capacity to grow profit margins, this suggests it has a clear and sustainable competitive advantage that should equate to further strong profit growth over the coming years.
This is set to complement an improving dividend outlook that was a further reason for our original ‘buy’ recommendation. Although the stock has a rather modest historic yield of 2.2pc, it is in the midst of raising its payout ratio from 50pc to 65pc of net profits. As a result, its interim dividend per share in the current year rose by 43pc. Assuming current earnings forecasts of high-single-digit growth prove to be accurate, and there is no change in its share price, the stock could be yielding around 3.3pc next year.
When added to its capital growth potential, this means Intertek continues to offer a favourable long-term risk/reward opportunity. Certainly, there are ongoing risks to its near-term financial and share price performance due to an uncertain economic outlook. But its solid fundamentals and earnings growth prospects mean that it has scope to deliver further gains and FTSE 100 outperformance over the coming years. 
Questor says: buyTicker: ITRKShare price at close: £51.05
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