Morningstar | SGS Verifies 2020 Ambitions; Shares Fairly Valued
Narrow-moat testing, inspection, and certification giant SGS took the opportunity at its recent capital markets day to update its medium-term guidance. It retained its organic growth guidance of mid-single-digit growth, in line with our thinking and rates reported most recently by peer Bureau Veritas, but trimmed its 2020 operating margin ambition from 18% to 17%. While some investors took exception with this reduction, we believe this modest level of margin accretion from today’s levels is eminently achievable and is very much in line with our prudent forecasts for the company. We reiterate our CHF 2,170 fair value estimate and believe the shares are currently fairly valued.Operating margin growth in the TIC sector is evolutionary, in our view, as sophisticated operators such as SGS naturally move up the value chain in terms of the services and products they offer. One such area in which this transition is evident is in the agriculture, food, and life business, where a shift toward areas such as food testing offers higher margins and better top-line growth rates than traditional agricultural services such as crop verification. Self-help also helps to increase margins incrementally, and the shift towards shared services across functions has led to demonstrable cost savings for the firm over the last few years.
The company’s presentation on M&A gave us cause for optimism as it laid out a clear strategy for disposing of businesses that don’t fit the high-margin and/or fast-growing criteria. Over the next 12 months, businesses that currently contribute $350 million in revenue will be disposed of, which should naturally have a positive mix effect on the group.
See our 2017 deep dive on the TIC sector, "A Narrow Moat Makes the Sector TIC."
SGS is engaged in the provision of inspection, verification, testing, certification and quality assurance services. Co.'s business lines include: Agricultural; Minerals; Oil, Gas & Chemicals; Life Science; Consumer Testing; Systems & Services Certification; Industrial; Environmental; Automotive; and Governments & Institutions. As of Dec 31 2014, Co.'s geographic operations were organized as follows: Europe, Africa, Middle East (Western Europe, Northern and Central Europe, Southern Central Europe, Eastern Europe & Middle East, and Africa); Americas (North America, and South America); and Asia Pacific (East Asia, China & Hong Kong, and South Eastern Asia & Pacific).
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