Deutsche Bank
Markets Research
Rating
Company
Buy
SGS
Date
11 November 2015
Company Update
Europe
Switzerland
Business Services
Outsourcers
Reuters
SGSN.VX
Bloomberg
SGSN VX
ADR Ticker
SGSOY
ISIN
US8188001049
Price at 10 Nov 2015 (CHF)
Exchange Ticker
VTX
SGSN
1,876.00
Price Target (CHF)
2,080.00
52-week range (CHF)
Some longer term reasons to buy
Buy SGS (TP CHF2080)
Buy into longer term growth and value creation.
2,154.00 - 1,626.00
Tom Sykes
Sylvia Foteva
Research Analyst
(+44) 20 754-76418
tom.sykes@db.com
Research Analyst
(+44) 20 754-13603
sylvia.foteva@db.com
Emily Roberts
Long term outperformer has good reasons to remain so
In our view, the recent investor days highlighted why the company should be a
long term outperformer of the market. The 2020 margin guidance was set at
>18% and whilst we believe it will be challenging to reach this, the operational
manager with the strongest track record in the SGS group has now been
appointed CEO and we believe investors will benefit from improved operational
performance and management of the Group’s portfolio of businesses.
Research Analyst
(+44) 20 754-73792
emily.roberts@db.com
You don’t have to believe the entire margin upside to be a buyer
SGS still sits at close to decade P/E relative lows and offers attractive upside in
a recovery and protection (3.6% div yield) in a slowdown, in our view. We
model a 2020 margin of 17% and 4.5% medium term in our DCF derived
CHF2080 12-month target price (previously CHF1960), which now offers 10%
upside and 14% TSR. We make some small changes to EPS from FX and
announced acquisitions nudging up our 15e EPS by 1% and 16e by 2%
Source: Deutsche Bank
Valuation and risk
We set our 12-month target price using a DCF valuation which uses a WACC
derived from a 1.0x beta, 4% risk free rate and 4% equity risk premium.
Downside risks include greater weakness in China macro data, Minerals and
Oil & Gas weakness in volumes and pricing, lower potential structural growth
and weakness in softlines and hardlines testing, less cross selling benefit than
we model, lower valuations for “bond proxy” equities as well less benefit from
maximizing the potential of the company’s small scale M&A.
Key changes
1,960.00 to ↑
2,080.00
Target Price
6.1%
Price/price relative
3200
2800
2400
2000
1600
11/12
5/13
11/13
5/14
11/14
5/15
SGS
SPI Swiss Performanc (Rebased)
Performance (%)
1m
3m
12m
Absolute
3.4
2.4
-12.7
SPI Swiss Performance
IX
2.0
-6.1
3.7
Source: Deutsche Bank
Forecasts And Ratios
Year End Dec 31
Revenue (CHFm)
EBITDA (CHFm)
DB EBITA (CHFm)
PBT DB (CHFm)
PBT stated (CHFm)
DB EPS (CHF)
OLD DB EPS (CHF)
% Change
DB EPS growth (%)
P/E (DB EPS) (x)
EV/EBITDA (x)
EV/EBITA (x)
DPS (CHF)
Yield (%)
2013A
5,830
1,210
977
939
874
84.55
84.55
0.0%
5.0
25.6
14.1
18.7
65.00
3.0
2014A
5,883
1,245
947
906
900
81.66
81.66
0.0%
-3.4
25.6
13.3
17.6
68.00
3.2
2015E
5,749
1,141
923
883
804
82.94
82.01
1.1%
1.6
22.6
13.4
18.1
68.00
3.6
2016E
6,111
1,301
985
942
942
89.85
88.13
1.9%
8.3
20.9
11.7
15.4
71.40
3.8
Source: Deutsche Bank estimates, company data
________________________________________________________________________________________________________________
Deutsche Bank AG/London
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should
be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should
consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST
CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015.
11 November 2015
Outsourcers
SGS
Fiscal year end 31-Dec
Model updated:10 November 2015
Running the numbers
2011
2012
2013
2014
2015E
2016E
73.15
70.13
65.00
263.3
80.51
70.86
58.00
270.3
84.55
77.80
65.00
280.1
81.66
79.07
68.00
303.4
82.94
74.80
68.00
244.2
89.85
89.85
71.40
259.3
8
11,740
12,010
8
14,053
14,566
8
16,567
17,085
8
16,055
16,587
8
14,340
15,252
8
14,340
15,173
P/E (DB) (x)
P/E (Reported) (x)
P/BV (x)
21.2
22.1
5.91
22.9
26.0
7.50
25.6
27.8
7.33
25.6
26.5
6.74
22.6
25.1
7.68
20.9
20.9
7.23
FCF Yield (%)
Dividend Yield (%)
2.8
4.2
2.7
3.1
3.4
3.0
3.6
3.2
4.8
3.6
4.6
3.8
2.5
11.8
15.2
2.6
13.1
17.5
2.9
14.1
18.7
2.8
13.3
17.6
2.7
13.4
18.1
2.5
11.7
15.4
4,797
2,162
1,015
191
34
790
-26
0
0
0
764
203
27
0
534
5,569
2,498
1,114
239
42
833
-41
0
0
0
792
214
34
0
544
5,830
2,602
1,210
253
45
912
-38
0
0
0
874
236
38
0
600
5,883
2,631
1,245
258
46
941
-41
0
0
0
900
254
37
0
609
5,749
2,599
1,141
252
45
844
-40
0
0
0
804
209
34
0
561
6,111
2,762
1,301
268
48
985
-43
0
0
0
942
240
40
0
662
23
557
74
618
52
652
20
629
61
622
0
662
669
-337
332
0
-510
716
-158
380
-84
752
-377
375
0
-521
25
-105
-226
-73
902
-333
569
0
-471
-3
-88
7
-29
869
-292
577
0
-523
366
-76
344
-109
1,005
-316
689
-500
-522
346
-13
0
119
995
-336
659
0
-546
-120
7
0
-16
1,211
888
1,044
1
1,616
4,760
1,305
1,410
2,715
1,995
50
2,045
94
987
1,015
1,172
17
1,800
4,991
1,322
1,551
2,873
2,060
58
2,118
335
973
1,029
1,216
18
1,803
5,039
1,308
1,519
2,827
2,143
69
2,212
335
1,350
1,043
1,337
24
2,013
5,767
1,690
1,674
3,364
2,327
76
2,403
340
1,350
1,069
1,330
24
1,868
5,641
2,036
1,648
3,685
1,866
110
1,976
686
1,350
1,097
1,323
24
1,953
5,747
1,916
1,718
3,634
1,982
150
2,133
566
0.8
-7.3
21.2
16.5
92.2
26.3
7.2
1.5
4.6
30.4
16.1
10.1
20.0
15.0
81.3
26.8
6.9
1.4
15.8
20.3
4.7
5.0
20.8
15.6
82.9
28.5
5.7
1.1
15.1
24.0
0.9
-3.4
21.2
16.0
85.7
27.2
5.0
1.0
14.1
22.9
-2.3
1.6
19.8
14.7
92.7
26.8
5.5
1.1
34.7
21.2
6.3
8.3
21.3
16.1
82.5
34.4
5.5
1.1
26.6
23.1
Financial Summary
DB EPS (CHF)
Reported EPS (CHF)
DPS (CHF)
BVPS (CHF)
Europe
Switzerland
Outsourcers
SGS
Reuters: SGSN.VX
Bloomberg: SGSN VX
Weighted average shares (m)
Average market cap (CHFm)
Enterprise value (CHFm)
Valuation Metrics
Buy
Price (10 Nov 15)
CHF 1,876.00
Target Price
CHF 2,080.00
52 Week range
CHF 1,626.00 - 2,154.00
Market Cap (m)
CHFm 14,340
USDm 14,242
EV/Sales (x)
EV/EBITDA (x)
EV/EBIT (x)
Income Statement (CHFm)
Company Profile
SGS is global leader in inspection, verification, testing and
certification. The company employs circa 64,000 people and
operates a network of more than 1,250 offices and laboratories
around the world. SGS operates the following ten divisions:
Agricultural Services, Minerals Services, Oil, Gas and Chemicals
Services, Life Science Services, Consumer Testing Services,
Systems and Services Certification, Industrial Services,
Environmental Services, Automotive Services and Governments
& Institutions Services. SGS provides industrial inspection,
analysis, testing, and verification services worldwide.
Price Performance
3200
2800
Sales revenue
Gross profit
EBITDA
Depreciation
Amortisation
EBIT
Net interest income(expense)
Associates/affiliates
Exceptionals/extraordinaries
Other pre-tax income/(expense)
Profit before tax
Income tax expense
Minorities
Other post-tax income/(expense)
Net profit
DB adjustments (including dilution)
DB Net profit
2400
2000
Cash Flow (CHFm)
1600
Nov 12 May 13 Nov 13 May 14 Nov 14 May 15
SGS
Cash flow from operations
Net Capex
Free cash flow
Equity raised/(bought back)
Dividends paid
Net inc/(dec) in borrowings
Other investing/financing cash flows
Net cash flow
Change in working capital
SPI Swiss Performance IX (Rebased)
Margin Trends
23
21
20
18
17
15
14
Balance Sheet (CHFm)
11
12
13
14
EBITDA Margin
15E
16E
EBIT Margin
Growth & Profitability
20
40
15
30
10
20
5
10
0
-5
Cash and other liquid assets
Tangible fixed assets
Goodwill/intangible assets
Associates/investments
Other assets
Total assets
Interest bearing debt
Other liabilities
Total liabilities
Shareholders' equity
Minorities
Total shareholders' equity
Net debt
0
11
12
13
14
15E
Sales growth (LHS)
Key Company Metrics
16E
ROE (RHS)
Solvency
40
35
30
25
20
15
10
5
0
30
20
10
0
11
12
13
Net debt/equity (LHS)
14
15E
16E
Sales growth (%)
DB EPS growth (%)
EBITDA Margin (%)
EBIT Margin (%)
Payout ratio (%)
ROE (%)
Capex/sales (%)
Capex/depreciation (x)
Net debt/equity (%)
Net interest cover (x)
Source: Company data, Deutsche Bank estimates
Net interest cover (RHS)
Tom Sykes
+44 20 754-76418
Page 2
tom.sykes@db.com
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Some longer term reasons
to buy
Longer term value creation and market outperformer
At the company’s investor days, the CEO and CFO of SGS gave one of the best
presentations we’ve seen in the sector over the last few years. They laid out
the parameters of strategic focus, cost efficiencies and capital allocation and
how management were now remunerated.
With the CEO now being the operational manager with the strongest track
record in the SGS group, we believe improved operational performance and
management of the Group’s portfolio of business will serve SGS investors well
in what is likely to be a lower growth trajectory than has historically been seen
for the business.
SGS remains one of our top picks. We are raising our target price to CHF2078,
which offers a further 10% upside and 14% TSR on a 12m view
In a release accompanying the investor day, SGS gave guidance and targets as
follows;
Figure 1: SGS guidance and 2020 targets
Revenues
Margin
Cash
2015e
2016e
~2% organic growth
~2.5% to 3.5% organic growth
Mid single digit
Stable ~16%
Stable ~16%
Adjusted operating margin > 18%
Solid cash flow
Solid cash flow
Acquisitions
ROIC
2016e to 2020e
Strong cash generation
CHF1bn of sales to be acquired
Solid ROIC
Source: Deutsche Bank, Company Data
If the company hits its 2020 guidance we would estimate an average 3% per
annum EBITA growth from margin improvement from 2017e to 2020e, 3-4%
from acquisitions, mid single digit organic growth and at the current price a
3.6% dividend yield. This would add up to ~15% TSR at mid single-digit
organic growth pre any further buy backs.
We think there is some conservatism in the 2016 margin guidance, but that
there is clearly ongoing uncertainty on the top line. Commodities could be
more of a drag than we forecast, but we still believe the top line can be a little
better next year and that the company can generate a double digit TSR.
SGS has historically outperformed global nominal GDP over the longer term
but underperformed in periods of strong economic recovery. The operating
margin target is a return to the previous peak, but this would likely be derived
from lower margins in Commodities and a more efficient business model.
Deutsche Bank AG/London
Page 3
11 November 2015
Outsourcers
SGS
Figure 2: SGS actual and forecast organic growth vs.
global nominal GDP
Figure 3: SGS operating margin forecasts vs. target
18.5
20
18.0
17.5
15
17.0
16.5
10
16.0
5
15.5
15.0
0
14.5
14.0
-5
13.5
-10
Global nominal GDP (YonY%)
SGS operating margin (%)
SGS organic growth (YonY%)
Source: Deutsche Bank, Datastream, Company Data
2020 target > 18%
Source: Deutsche Bank, Company Data
Following recent acquisitions and FX changes we are adjusting our forecasts
as per the table below. We retain 2% organic growth and nudge up slightly our
operating margin to 16.1%. We nudge down our organic growth from 4% to
3% for 16e due to commodity weakness and we nudge down our operating
margin forecast to 16.1%. Adding acquisitions and FX lead us to upgrade our
EPS forecast by 1% for 15e and 2% for 16e.
Figure 4: Forecast changes
Old
New
Change
15e
16e
15e
16e
15e
16e
Revenue
5,701
5,966
5,749
6,111
0.8%
2.4%
Organic (%)
1.9%
4.3%
1.8%
2.8%
915
970
923
985
0.9%
1.5%
16.0%
16.3%
16.1%
16.1%
1.1%
1.9%
EBITA
EBITA margin (%)
EPS
82.0
88.1
82.9
89.9
EPS growth
0.3%
7.5%
1.5%
8.3%
Source: Deutsche Bank
On our revised forecasts the company sits on the following multiples.
Figure 5: Current valuations
2015e
2016e
2017E
EV/EBITDA
12.4
11.4
13.9
EV/EBITA
16.4
15.0
13.9
P/E
22.9
21.1
19.5
FCF to EV (%)
4.9
4.8
5.1
Dividend yield (%)
3.6
3.8
3.9
Source: Deutsche Bank
Page 4
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Do we need to believe all the 2020 guidance in order to be a buyer? We
suspect not.
We are raising our DCF based target price to CHF2080 from CHF1960. Our
DCF uses a WACC of 7.5% derived from a 1.0x beta, 4% risk free rate and a
4% equity risk premium.
We model 4.5% medium term growth and a rise in the margin to 17.0% by
2020. We do not model further acquisitions. We have assumed that not all
future costs savings will accrue to the company and that some will be
competed away. We note that the company have given a long term target of at
least 18% and are confident of generating significant cost savings, however,
we feel that a more cautious, risk adjusted view is warranted currently.
Modelling an 18% 2020 operating margin pre acquisitions would add c.6% to
our DCF.
SGS is still an absolute and relative buy, in our view. We have a very cautious
macro view and as such we believe positive market returns will be hard to
make over the next couple of years. As such our view is that quality businesses
at historically low valuations are a sensible place to be due to the potential for
top line improvement if the economy is stronger than we think and rating
protection if it isn’t. SGS also has a 3.6% dividend yield which offers
protection.
SGS currently trades close to P/E relative lows seen over the last decade and at
levels where we have previously seen the company start to materially
underperform the markets EPS rather than outperform.
Figure 6: SGS P/E vs. market P/E
Figure 7: SGS P/E relative
1.2
2.5
3.0
2.8
2.6
2.4
2.2
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
1.0
2
0.8
1.5
0.6
1
0.4
0.5
0.2
0
0.0
SGS P/E relative
Source: Deutsche Bank, Datastream
Current
SGS EPS vs market EPS
SGS P/E relative
Source: Deutsche Bank, Datastream
However, over the long term we believe that the business model and improved
profitability will enable the company to beat market EPS growth, which at the
current relative multiple we expect will enable them outperform the stock
market (even on a high 21x 16e P/E).
Deutsche Bank AG/London
Page 5
11 November 2015
Outsourcers
SGS
Figure 8: SGS EPS performance vs. the market
Figure 9: SGS EPS and share price relative to the market
1.6
1.2
1.4
1.0
1.2
0.8
1
0.6
0.8
0.4
0.6
0.2
0.4
0.0
0.2
0
SGS EPS relative
Source: Deutsche Bank, Datastream
SGS share price relative to market (in USD)
SGS EPS relative to market (in USD)
Source: Deutsche Bank, Datastream
Figure 10: SGS fwd EPS vs. market fwd EPS in USD
Figure 11: SGS relative share price performance (log
scale)
6000
1
600
0.1
60
SGS share price in USD
Source: Deutsche Bank, Datastream
Expon. (SGS share price in USD)
Share price performance relative to European market
Expon. (Share price performance relative to European market)
Source: Deutsche Bank, Datastream
One risk to the multiple is that US interest rate rises reduce the multiple people
want to pay for the perceived “bond proxies” in the equity market. SGS with
its steady growth and high dividend yield is on the edge of this category. The
charts below show the movement in the SGS P/E vs. the Federal funds rate
and the P/E relative also vs. Federal funds rate.
There is no clear conclusion that interest rate rises have been a cause for a
decline in the P/E multiple or indeed for the relative multiple and stock specific
factors have been far more important but it is a perceived risk in the short
term. We would look through this currently.
Page 6
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Figure 12: SGS fwd 12m P/E vs. Federal Funds rate
12
Figure 13: SGS P/E relative vs. Federal funds rate
45
40
10
35
8
30
25
6
20
4
15
10
2
5
0
0
US FEDERAL FUNDS TARGET RATE (EP)
Source: Deutsche Bank, FRB, Datastream
Deutsche Bank AG/London
SGS fwd 12m P/E
12
2.5
10
2
8
1.5
6
1
4
2
0.5
0
0
US FEDERAL FUNDS TARGET RATE (EP)
SGS fwd 12m P/E relative
Source: Deutsche Bank, FRB, Datastream
Page 7
11 November 2015
Outsourcers
SGS
Highlights of the investor days
Below we go through some of the key themes of the main presentation by the
CEO and CFO
Realignment
The reporting structure has been updated to better align smaller business
units. The updated divisional structure is shown below. The company will
continue to report under the existing infrastructure until 2016.
The main changes were;
the creation of the Agriculture, Food and Life division which involves the
rolling together of the Agri business, with food from Consumer Testing and the
Life Sciences business.
the creation of the Consumer and Retail division, where the business will be
refocused on traditional softlines and hardlines, electronics and HPC.
Generating growth from technology will be a key focus.
the creation of the Transport division with a broader remit to target Aerospace,
Marine & Rail as well as the traditional Auto’s business.
the creation of the Certification and Business Enhancement division attempting
to move the company away from compliance only certification to becoming a
solution provider including management systems and performance
assessments, SGS Academy and supply chain verification.
There will also be more regional focus. The number of regions will fall from 10
to 8 and the company aim to increase their exposure to North America and
China.
SGS aims to increase its N.Am exposure by 50% out to 2020 (including
acquisitions) and to diversify away from O&G, Minerals and Industry which
account for over 70% of N.Am revenues currently (N.Am = c.9% of employees
and ~ 15% of sales).
The company is also targeting over 50% growth in China including acquisitions
with a focus on the shift from the export to the local market (the local market
currently account for 40% of SGS China (China accounts for c.15% of
employees and ~12% sales).
The company was keen to highlight the increased use of technology both as a
driver of efficiencies and a driver of new services. Increased automation,
digitalization and data analytics (so called TIC 4.0) may have an incremental
benefit but we are not sure whether this is an incremental productivity gain.
We believe that TIC companies have generally been surprisingly poor at using
data to find new revenue streams (vs. increases in trade, globalisation etc) so
we believe there could be some gains here but that they will be incremental.
Page 8
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Increased business performance management
The new CEO is the operational manager with the strongest track record in the
SGS group, and we believe that increased monitoring and management of the
business units will lead to “yield” improvement in the portfolio. The company
is being divided into 50 business segments (i.e. hardlines, Softline etc) with a
dashboard for monitoring the businesses based on growth, margin, cash flow
and strategic significance.
Whilst this isn’t in itself radical in business thinking it is important to note that,
in our view, SGS has been run on an entrepreneurial culture, which has been
good for growth but less good for portfolio management. The company is now
saying that it will review all businesses that have less than 5% growth and
make less than a 10% operating margin and that there should be a maximum 3
year incubation for new growth businesses before it hits a steady state of
profitable growth or enters full or partial disposal.
The company outlined how it wanted to generate;
1)
Back office efficiency through shared service centres
2)
Focus on agile sustainable business models
3)
Generate enhanced analytics to track performance
4)
Grow talent in support functions
5)
Leverage technology
It will have completed benchmarking studies on its support functions (Finance,
Procurement, HR and IT) by end of 2015. The company intends to set up three
shared service centres affecting 1500 employees (1.7% of SGS workforce) and
that ultimately this will save c.CHF20m by 2018.
By far the biggest cost savings were seen as coming from procurement with
the company outlining a run rate of CHF180m of procurement savings by 2017
of which 80% were in opex and 20% in capex. This would be worth a gross
220bps on our 2017e operating margin and 250bps including the shared
service centre savings.
When we look at the cost breakdown of SGS over the last decade it is not
immediately obvious where the cost savings should come from. The biggest
percentage change from 2010 (when the company was last at ~18% margin)
in costs is from wages and salaries which have increased from 46.8% to
49.1%. This would not seem to immediately fit within procurement savings.
Figure 14: SGS cost breakdown
Cost category
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Salaries and wages
48.8%
47.6%
47.5%
46.6%
47.3%
46.8%
48.0%
49.1%
49.2%
49.1%
Consumables & RMI
6.3%
6.8%
6.6%
7.0%
6.6%
6.5%
6.6%
6.7%
6.5%
6.8%
Travel costs
6.6%
6.6%
6.5%
6.6%
6.1%
6.5%
6.6%
6.5%
6.4%
6.4%
Subcontractors'
6.6%
6.9%
7.0%
6.9%
6.8%
6.6%
6.9%
6.1%
6.1%
6.1%
Depn. & Amort.
4.2%
4.5%
4.5%
4.4%
4.8%
4.7%
4.7%
5.0%
5.1%
5.2%
Rental, insurance, utils
5.3%
5.1%
4.8%
4.5%
4.6%
4.6%
4.6%
4.8%
4.8%
4.9%
Communication costs
2.5%
2.5%
2.4%
2.2%
2.1%
2.1%
2.0%
1.9%
1.8%
1.8%
Miscellaneous
4.6%
4.2%
4.5%
5.0%
4.9%
4.7%
4.1%
4.9%
4.3%
3.7%
Source: Deutsche Bank, Company Data
Deutsche Bank AG/London
Page 9
11 November 2015
Outsourcers
SGS
However, the company highlighted savings that it can make in better sourcing,
improved supply chain management, real estate and supplier consolidation
and partnerships.
This cost saving will not all fall through to the bottom line (and one might
argue some will be competed away as it is tough to hang on to procurement
gains) but certainly in the near term the company will be investing to set up
shared service centres and other operational improvements. One should bear
in mind though that in 2016 the company estimates that it will make an
incremental CHF60m of procurement gains and will get c.CHF20m carry over
from costs savings this year (we estimate), which, in our view makes the 2016
guidance look conservative, especially if pricing pressure in Commodities is
slowing down.
We also note the close alignment of management’s STIP & LTIP linked to
operational metrics with remuneration based on organic growth, profitability,
cash flow and ROIC and the operations council members will now have to
build a stake of 2x annual salary in shares and 3x for the CEO.
The dividend was confirmed at the same level as last year at CHF68.
Other points from the other presentations to highlight;
Oil and Gas divisional growth will likely be similar to H1 ().2% organic) with
trade (40% of the O&G) seeing 5% growth due to market volatility helping to
offset weakness elsewhere in upstream. Expectations are for 3 to 4% trade
growth next year.
Depreciation of underutilised assets in O&G is continuing at the same rate
despite the lower usage. If these assets become increasingly utilised beyond
their current expected life (which they may well do if not being used now) then
this could be a structural driver of margins in the Oil & Gas period in year 20172020, in our view, even without an improvement in top line.
Minerals remains a tough market and in our view could see a weaker H2,
despite adding 15 more labs in 15e and 4 more already to be added next year.
2016 is expect to see the full effect of lower commodity prices
CTS growth remains robust, albeit with pressure on softlines and hardlines.
Autos and Food remain areas of strong growth.
Restructuring costs are in the company’s margin guidance
The biggest opportunities in China seem to be Industrial and Food rather than
in Consumer and the movement of low value manufacturing inland or abroad
may be accelerating. The Trans Pacific Partnership could make China less
attractive as a manufacturing destination.
Page 10
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Why did we upgrade SGS initially?
We upgraded SGS in May as we believed the valuation more than took into
account the near term commodities concerns but overlooked the company’s
longer term earnings power.
Our view remains that structural market growth in the industry will be lower
than we have seen historically. As such our belief is that those companies that
will be the most successful will be those that are in high growth monolines
(like Food or Non-Destructive Testing) or Groups that maximize the cross
selling potential between the different business lines they operate in and
elevate their own growth rates above those of the market.
SGS has now added a stronger margin component than we thought was likely.
Figure 15: Sector revenue breakdown (2014E)
Sales
SGS
BV
Minerals
12%
7%
ITRK
4%
Oil, Gas and Chemicals
25%
23%
39%
Consumer (Toys, Textiles, Electrical and Electronics)
16%
11%
30%
Industry ex O&G
11%
7%
10%
Systems & Certification
7%
21%
5%
Auto and related
5%
3%
3%
Marine
8%
Construction
4%
11%
2%
Govt Services
4%
6%
3%
10%
3%
4%
6%
0%
0%
Minerals and O&G
37%
30%
43%
Minerals & O&G and Consumer
53%
41%
73%
Food & Agri
Environmental (ex O&G)
Source: Deutsche Bank
Putting in an exact figure on a company’s cross selling ability is impossible.
However, we start from the point of view that at the very least the business
mix of SGS and BV (Hold, TP Eur20.2, Eur19.10) is more conducive to cross
selling than that of Intertek (Hold, TP 2654p, 2534p). We believe there is more
commonality in the potential client base across Industry, Systems and
Certification, Construction, Auto and Environmental than certainly there would
be say between Oil & Gas and Consumer. As such we believe that SGS and BV
are at a starting point advantage for the longer term growth if structural end
market growth is going to be lower.
Since 2007, SGS has generated an average 7.6% organic growth rate since
2007 and BV has generated 5.9% (Intertek 7.1%). We could consider this may
be due to geographical mix, it may be due to end market mix, however, we
also believe that the matrix structure of SGS and commerciality or incentive
structures have up to now led it to being better at generating incremental
growth above market levels and that the company is especially good at
maximizing the potential of acquisitions.
Deutsche Bank AG/London
Page 11
11 November 2015
Outsourcers
SGS
We note recently too, the large account initiative at BV and the commentary on
cross selling from the Intertek CEO which could lead to increased competition
but to us just merely highlights the need to cross sell.
Figure 16: Sector organic growth (YonY%)
Figure 17: SGS organic growth vs. global nominal GDP
20%
18%
16%
14%
15%
12%
10%
10%
8%
6%
5%
4%
2%
0%
0%
-2%
-5%
SGS
Source: Deutsche Bank, Company Data
Page 12
BV
ITRK
Global nominal GDP (%)
SGS organic growth (%)
Source: Deutsche Bank, Datastream
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Risks to the view
Downside risks to our positive stance revolve around greater weakness in
China and in the Mineral and Oil & Gas businesses than we forecast with a risk
of lower volume and more negative pricing than is currently priced in.
Downside risk also stems from lower potential structural growth and less cross
selling benefit than we model and less benefit from maximizing the potential of
the company’s small scale M&A.
We note that world trade growth continues to be at the low end of its historical
range and a drag on growth. We can also see the recent weakness in toy and
particularly textiles exports from China, this could be due to weaker economic
growth or the structural shift out of China (i.e. to Vietnam or Bangladesh). If it
is a structural shift then SGS will have to capture the other side of the move
and this may lead some price weakness. We note however, that the SGS P/E
relative is at the level last seen when we saw similar weakness.
Figure 18: World trade growth (YonY%, USD)
Figure 19: Chinese toy & textile exports vs. SGS P/E
relative
20%
50%
15%
40%
10%
30%
5%
20%
2.5
2
1.5
10%
0%
1
0%
-5%
-10%
-10%
0.5
-20%
-15%
-30%
0
-20%
WD ITS TRADE IN GOODS AND SERVICES CONA
Source: Deutsche Bank, IMF
Current
Combined Chinese textiles and toy exports rolling 3m (YonY%)
SGS P/E relative (x)
Source: Deutsche Bank, CSO, Datastream
Commodities will likely weigh on growth in 2016. Oil & Gas capex remains
weak and the likelihood is that support activities will come under further
pressure
Deutsche Bank AG/London
Page 13
11 November 2015
Outsourcers
SGS
Figure 20: Oil and Gas drilling US vs. oil price
Figure 21: Employment in O&G support activities vs, oil
price
160
15%
450
140
10%
400
120
5%
100
300
0%
250
-5%
200
80
60
350
150
-10%
40
20
-15%
0
-20%
US INDL PROD - DRILLING OIL & GAS WELLS VOLA
100
50
0
US EMPLOYED-SUPPORT ACTIVITIES FOR OIL & GAS OPERATIONS VOLN
Brent crude $/bbl
Source: Deutsche Bank
Real oil price
Source: Deutsche Bank
There are limited clear indicators on pricing, however, we can get a decent
breakdown of pricing trends in the US via the PPI data. Figures 22 and 23
show the movement in the PPI for support activities for Metal Mining, Coal
Mining and Oil & Gas operations. We can see that whilst pricing was very
strong during the commodities boom, that pricing overall since 2005/06 is in
line with finished goods inflation (admittedly goods not services but a useful
overall indicator) suggesting that the majority of the pricing reductions may
already have happened, with the large part of pricing improvements occurring
in the early part of the last decade as a catch up to years of weak oil prices.
Figure 22: PPI for support activities for metal mining,
coal mining and O&G operations
Figure 23: US PPI for support activities for metal mining,
coal mining and O&G vs. core PPI for finished goods
220
120
200
110
180
100
160
90
140
80
120
70
60
100
50
80
US PPI: SUPPORT ACTIVITIES FOR METAL MINING NADJ
US PPI: SUPPORT ACTIVITIES FOR OIL AND GAS OPERATIONS NADJ
US PPI: SUPPORT ACTIVITIES FOR COAL MINING NADJ
Source: Deutsche Bank, BLS
Page 14
US PPI: SUPPORT ACTIVITIES FOR METAL MINING NADJ
US PPI - FINISHED GOODS LESS FOODS & ENERGY (CORE) SADJ
US PPI: SUPPORT ACTIVITIES FOR COAL MINING NADJ
US PPI: SUPPORT ACTIVITIES FOR OIL AND GAS OPERATIONS NADJ
Source: Deutsche Bank, BLS
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Figure 24: Revenue forecasts
Year end 31 December
2014
2015E
2016E
2017E
387.1
379.2
407.0
431.4
Revenues
Agricultural Services
Minerals Services
Oil, Gas & Chemicals Services
Life Science Services
702.7
652.6
694.1
728.8
1,201.0
1,142.4
1,157.3
1,215.2
212.7
201.2
210.0
216.3
1,093.1
1,120.2
1,212.0
1,284.7
Systems & Services Certification
414.6
417.0
447.7
474.6
Industrial Services
977.0
898.1
965.3
1,013.6
Environmental Services
342.4
372.3
403.3
429.6
Automotive Services
302.8
313.1
340.3
354.0
Governments & Institutions Services
249.5
253.1
274.4
290.8
5,882.9
5,749.1
6,111.4
6,438.9
Consumer Testing Services
Total revenues
Revenue Growth
Agricultural Services
1.5
-2.1
7.3
6.0
-11.3
-7.1
6.4
5.0
Oil, Gas & Chemicals Services
5.4
-4.9
1.3
5.0
Life Science Services
3.8
-5.4
4.4
3.0
Consumer Testing Services
4.9
2.5
8.2
6.0
Systems & Services Certification
3.2
0.6
7.4
6.0
Industrial Services
1.7
-8.1
7.5
5.0
Environmental Services
4.4
8.7
8.3
6.5
Automotive Services
-0.8
3.4
8.7
4.0
Governments & Institutions Services
-9.2
1.4
8.4
6.0
0.9
-2.3
6.3
5.4
Minerals Services
Total revenues
Organic Growth
Agricultural Services
6.6
4.7
6.0
6.0
-3.5
-2.5
-1.4
5.0
Oil, Gas & Chemicals Services
8.6
0.1
0.0
5.0
Life Science Services
5.5
1.2
3.0
3.0
Consumer Testing Services
6.9
4.9
6.0
6.0
Systems & Services Certification
5.9
6.3
6.0
6.0
Industrial Services
2.4
-3.7
-1.4
5.0
Environmental Services
0.3
5.6
6.5
6.5
Automotive Services
3.5
6.3
6.0
4.0
-0.4
8.2
7.0
6.0
4.0
1.8
2.8
5.4
Minerals Services
Governments & Institutions Services
Total
Source: Company data, Deutsche Bank
Deutsche Bank AG/London
Page 15
11 November 2015
Outsourcers
SGS
Figure 25: EBITA forecast
Year end 31
December
2014
2015E
2016E
2017E
Agricultural Services
63.8
63.6
68.2
73.6
Minerals Services
98.8
86.3
86.8
93.3
144.5
127.7
129.4
139.5
EBITA (Adjusted Operating Profit)
Oil, Gas & Chemicals Services
Life Science Services
Consumer Testing Services
Systems & Services Certification
19.9
19.2
20.0
21.3
269.7
271.6
300.6
322.5
73.9
71.5
77.9
84.0
122.6
115.7
124.7
134.0
Environmental Services
34.3
50.3
50.7
55.3
Automotive Services
62.0
58.9
64.0
67.6
Governments & Institutions Services
57.9
58.1
62.4
67.0
947.4
923.0
984.8
1,058.2
Industrial Services
Total EBITA
Reported growth (%)
Agricultural Services
-2.3
-0.3
7.3
7.9
-19.9
-12.6
0.5
7.5
-6.2
-11.6
1.3
7.8
-26.6
-3.5
4.3
6.2
Consumer Testing Services
4.4
0.7
10.7
7.3
Systems & Services Certification
0.8
-3.2
8.9
7.8
14.3
-5.6
7.8
7.4
Minerals Services
Oil, Gas & Chemicals Services
Life Science Services
Industrial Services
Environmental Services
1.5
46.6
0.9
9.1
-5.8
-5.0
8.6
5.7
-15.1
0.3
7.4
7.4
-3.0
-2.6
6.7
7.5
Agricultural Services
16.5
16.8
16.8
17.1
Minerals Services
14.1
13.2
12.5
12.8
Oil, Gas & Chemicals Services
12.0
11.2
11.2
11.5
9.4
9.5
9.5
9.8
Consumer Testing Services
24.7
24.2
24.8
25.1
Systems & Services Certification
17.8
17.1
17.4
17.7
Industrial Services
12.5
12.9
12.9
13.2
Environmental Services
10.0
13.5
12.6
12.9
Automotive Services
20.5
18.8
18.8
19.1
Governments & Institutions Services
23.2
23.0
22.8
23.1
Total EBITA
16.1
16.1
16.1
16.4
Automotive Services
Governments & Institutions Services
Total EBITA
Margins (%)
Life Science Services
Source: Company data, Deutsche Bank
Page 16
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Appendix 1
Important Disclosures
Additional information available upon request
Disclosure checklist
Company
Ticker
Recent price*
Disclosure
SGS
SGSN.VX
1,876.00 (CHF) 10 Nov 15
14,15
*Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other
information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the
primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at
http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.
Important Disclosures Required by U.S. Regulators
Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States.
See Important Disclosures Required by Non-US Regulators and Explanatory Notes.
14. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from this company
within the past year.
15. This company has been a client of Deutsche Bank Securities Inc. within the past year, during which time it received
non-investment banking securities-related services.
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this
research, please see the most recently published company report or visit our global disclosure look-up page on our
website at http://gm.db.com/ger/disclosure/Disclosure.eqsr?ricCode=SGSN.VX
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the
subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive
any compensation for providing a specific recommendation or view in this report. Tom Sykes
Deutsche Bank AG/London
Page 17
11 November 2015
Outsourcers
SGS
Historical recommendations and target price: SGS (SGSN.VX)
(as of 11/10/2015)
3,000.00
Previous Recommendations
Strong Buy
Buy
Market Perform
Underperform
Not Rated
Suspended Rating
2,500.00
1
4
2
56
3
7
9
Security Price
2,000.00
8
10
Current Recommendations
1,500.00
Buy
Hold
Sell
Not Rated
Suspended Rating
1,000.00
*New Recommendation Structure
as of September 9,2002
500.00
0.00
Nov 12 Feb 13 May 13 Aug 13 Nov 13 Feb 14 May 14 Aug 14 Nov 14 Feb 15 May 15 Aug 15
Date
1.
14/06/2013:
Hold, Target Price Change CHF1,925.00
6.
18/07/2014:
Hold, Target Price Change CHF1,882.00
2.
10/09/2013:
Hold, Target Price Change CHF2,122.00
7.
04/12/2014:
Hold, Target Price Change CHF2,100.00
3.
22/11/2013:
Hold, Target Price Change CHF2,120.00
8.
23/01/2015:
Hold, Target Price Change CHF1,610.00
4.
12/02/2014:
Hold, Target Price Change CHF2,067.00
9.
28/05/2015:
Upgrade to Buy, Target Price Change CHF1,975.00
5.
14/07/2014:
Hold, Target Price Change CHF1,959.00
10. 25/06/2015:
Equity rating key
Buy: Based on a current 12- month view of total
share-holder return (TSR = percentage change in
share price from current price to projected target price
plus pro-jected dividend yield ) , we recommend that
investors buy the stock.
Sell: Based on a current 12-month view of total shareholder return, we recommend that investors sell the
stock
Hold: We take a neutral view on the stock 12-months
out and, based on this time horizon, do not
recommend either a Buy or Sell.
Notes:
1. Newly issued research recommendations and
target prices always supersede previously published
research.
2. Ratings definitions prior to 27 January, 2007 were:
Buy, Target Price Change CHF1,960.00
Equity rating dispersion and banking relationships
400
350
300
250
200
150
100
50
0
56 %
39 %
50 %
39 %
5 % 42 %
Buy
Hold
Companies Covered
Sell
Cos. w/ Banking Relationship
European Universe
Buy: Expected total return (including dividends)
of 10% or more over a 12-month period
Hold:
Expected
total
return
(including
dividends) between -10% and 10% over a 12month period
Sell: Expected total return (including dividends)
of -10% or worse over a 12-month period
Page 18
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
Regulatory Disclosures
1.Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the
"Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
2.Short-Term Trade Ideas
Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are
consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the
SOLAR link at http://gm.db.com.
Deutsche Bank AG/London
Page 19
11 November 2015
Outsourcers
SGS
Additional Information
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"Deutsche Bank"). Though the information herein is believed to be reliable and has been obtained from public sources
believed to be reliable, Deutsche Bank makes no representation as to its accuracy or completeness.
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Derivative transactions involve numerous risks including, among others, market, counterparty default and illiquidity risk.
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Page 20
Deutsche Bank AG/London
11 November 2015
Outsourcers
SGS
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Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the
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Prudential Regulation Authority and is subject to limited regulation by the Prudential Regulation Authority and Financial
Conduct Authority. Details about the extent of our authorisation and regulation are available on request.
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Korea:
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Co.
South Africa: Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register
Number
in
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arising from, or in connection with, this report. Where this report is issued or promulgated in Singapore to a person who
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regulations),
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instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA,
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involved in stock transactions - for stock transactions, we charge stock commissions and consumption tax by
multiplying the transaction amount by the commission rate agreed with each customer. Stock transactions can lead to
losses as a result of share price fluctuations and other factors. Transactions in foreign stocks can lead to additional
losses stemming from foreign exchange fluctuations. We may also charge commissions and fees for certain categories
of investment advice, products and services. Recommended investment strategies, products and services carry the risk
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Deutsche Bank AG/London
Page 21
11 November 2015
Outsourcers
SGS
relevant disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in
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name of the entity. Reports on Japanese listed companies not written by analysts of DSI are written by Deutsche Bank
Group's analysts with the coverage companies specified by DSI. Some of the foreign securities stated on this report are
not disclosed according to the Financial Instruments and Exchange Law of Japan.
Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may
from time to time offer those securities for purchase or may have an interest to purchase such securities. Deutsche Bank
may
engage
in
transactions
in
a
manner
inconsistent
with
the
views
discussed
herein.
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Regulatory Authority. Deutsche Bank AG - QFC Branch may only undertake the financial services activities that fall
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District,
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Box
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Tower
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Arabia.
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Please
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Copyright © 2015 Deutsche Bank AG
Page 22
Deutsche Bank AG/London
David Folkerts-Landau
Chief Economist and Global Head of Research
Raj Hindocha
Global Chief Operating Officer
Research
Marcel Cassard
Global Head
FICC Research & Global Macro Economics
Steve Pollard
Global Head
Equity Research
Michael Spencer
Regional Head
Asia Pacific Research
Ralf Hoffmann
Regional Head
Deutsche Bank Research, Germany
Andreas Neubauer
Regional Head
Equity Research, Germany
International locations
Deutsche Bank AG
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Australia
Tel: (61) 2 8258 1234
Deutsche Bank AG
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Germany
Tel: (49) 69 910 00
Deutsche Bank AG London
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London EC2N 2EQ
United Kingdom
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Deutsche Bank Securities Inc.
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United States of America
Tel: (1) 212 250 2500
Deutsche Bank AG
Filiale Hongkong
International Commerce Centre,
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Hong Kong
Tel: (852) 2203 8888
Deutsche Securities Inc.
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Chiyoda-ku, Tokyo 100-6171
Japan
Tel: (81) 3 5156 6770