BVVBY - Bureau Veritas: Attractive On A Pullback

2023-10-05 10:30:00 ET

Summary

• Bureau Veritas is a 200-year-old company and one of the largest independent testing, inspection, and verification companies in the world.
• The company reported strong financial results in the first half of 2023, with a 9.4% organic revenue growth and increased interest income.
• Veritas has a robust balance sheet and has increased its dividend payout ratio from 50% to 65%.

Introduction

Bureau Veritas ( BVRDF ) ( BVVBY ) is a 200-year-old company and one of the largest independent testing, inspection and verification companies in the world. The company is active in pretty much every sector and is able to service its clients from in excess of 1,500 offices and laboratories worldwide. Veritas has an excellent reputation, and its services continue to be in high demand for that very reason. In an article that was published about two years ago, I mentioned the company's cash flow performance was robust but the sub-4% free cash flow yield was a bit low

Veritas is a French company and the liquidity on its French listing is clearly superior to any other secondary listing. Trading with BVI as its ticker symbol on Euronext Paris, the average daily volume is approximately 500,000 shares and that makes Paris the best venue to trade in Veritas' shares. The current market cap based on about 452M shares outstanding is just over 10.4B EUR.

Is it still a cash flow machine?

As mentioned, Bureau Veritas is a leader in the Testing, Inspection and Certification ('TIC') services, and it provides these services in three pillars. It is a 'first party' to clients that engage Veritas to ensure their products meet the required standards. The 'second party' segment is where Veritas comes in on the other side of that equation when it is hired by for instance wholesalers acquiring batches of a certain product from the manufacturer. And finally, it also is a 'third party' where it acts as an independent body.

As the reputation of these TIC companies is very important (customers aren't really interested in certification by an unknown agency), the TIC companies generally have some pricing power and a continuous demand for their services. Competitor SGS ( SGSOY ) ( SGSOF ) which I discussed in this article has been guiding for a strong performance , so I wanted to catch up on Bureau Veritas as well.

Veritas also started 2023 with a bang. It reported a total 7.8% revenue increase including a 9.4% organic revenue growth. The total revenue generated in the first semester was approximately 2.9B EUR, but unfortunately this did not translate into a higher operating profit. As you can see below, there was a 15M EUR difference in provisions compared to the first half of last year while the 'other operating income' came in slightly lower as well. But despite these elements, the total operating profit decreased by just over 0.5% to just under 373M EUR.

On a positive note, the company's cash pile is now proving to be pretty valuable in the current environment of increasing interest rates. The total interest income increased from 1.4M EUR in H1 2022 to 22.4M EUR in H1 2023. And although the finance expenses increased as well, the net finance cost decreased by just over 14M EUR. This resulted in a pre-tax income of 358M EUR and a net profit of 245M EUR of which 232.5M EUR was attributable to the shareholders of Bureau Veritas. Divided over the 452M shares outstanding, the EPS was 0.51 EUR. The adjusted EPS (excluding elements like impairment charges) was 0.61 EUR.

In the previous article, which was published in 2021, I commented on Veritas' cash flow profile: thanks to a capex-light business model, the company is able to report strong cash flows.

In the first half of this year, Veritas reported an operating cash flow of 222M EUR, but this includes a 196M EUR investment in the working capital position. On the other hand, we should still deduct about 9M EUR in taxes that were owed but not paid during H1. Additionally, the 78M EUR in lease payments and interest payments should be deducted as well.

This results in an adjusted operating cash flow of 331M EUR. And as you can see in the image above, the total capex (excluding acquisitions) was 80M EUR, resulting in a net free cash flow of 251M EUR of which approximately 240M EUR would be attributable to the shareholders of Bureau Veritas.

That's slightly higher than the reported net income, mainly due to the impact of the provisions. These are non-cash charges that are included in the income statement, but there hasn't been a corresponding cash outflow yet. Of course there eventually will be cash outflows related to provisions, but my purpose is to calculate the underlying free cash flow generated by the business in a steady state.

The strong results in the first half of the year have allowed Veritas to hike its full-year expectations. The company is now expecting a mid to high single digit organic revenue growth (up from a mid-single digit) while the margins should remain stable and the cash conversion ratio should exceed 90%. Note: the cash conversion ratio is not a synonym for free cash flow. According to Veritas' definition, it represents the operating cash flow versus the adjusted operating profit.

The strong cash flow could be useful to the company and its shareholders. As Veritas has a pretty robust balance sheet, the payout ratio for the dividend has increased from 50% to 65%. Indeed, at the end of June, the company had about 1.69B EUR in cash on the balance sheet while there was just under 2.1B EUR in long-term debt and 531M EUR in short-term debt for a total net debt of just under 950M EUR. The maturity dates of the debt are well spread out in time, as you can see below.

The market clearly isn't too worried about Bureau Veritas as the January 2027 bonds are trading at a yield to maturity of around 4.5% which still is pretty decent.

Investment Thesis

While I anticipate the interest expenses to increase, the interest income should increase as well and on top of that, Veritas is in the luxury position to simply repay (a portion of) the gross debt upon the maturity dates rather than refinancing the entire amount.

I expect Veritas to report a full-year EPS of around 1.03-1.05 EUR while the adjusted EPS should be closer to 1.20 EUR per share. Looking at the company from a free cash flow perspective, I expect a full-year free cash flow result of 1.10 EUR per share, which would mean the stock is currently trading at a free cash flow yield of approximately 4.75%. That makes the stock somewhat more attractive than two years ago when looking at the absolute numbers, but in this day and age 'there is no alternative' is no more. Investors do have alternatives and could easily purchase bonds or other fixed income securities offering similar underlying returns. Veritas does have the possibility to pursue M&A but the non-organic growth will likely be pretty low.

I do think the company is attractive at the current share price, but I also think there is no rush. The consensus estimates are expecting an EPS of 1.30 EUR per share in 2025 which could be reasonable but that still means the stick is trading at 17 times earnings. I considered writing put options, but the low volatility levels mean the option premiums are too low to be interesting. I'll just continue to track the stock while waiting for an opportunity to establish a position.

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