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Analysis - Oil drilling, toy safety rules boost inspection firms

ZURICH (Reuters) - European inspection firms are eying a sales boost from tighter rules in oil drilling and toy safety after high-profile accidents and product recalls galvanised regulators into action.

BP's BP.L massive oil spill in the Gulf of Mexico and recent recalls of toxic toys or faulty cars have had the effect of prompting regulators to create new rules, which offers juicy business opportunities to testing and inspection firms.

New frameworks could add a couple of percentage points to sales growth in testing, inspection and certification (TIC), returning the sector growth to high single-digit levels by the end of 2010, said Exane BNP Paribas analyst Laurent Brunelle.

TIC firms' relatively high valuations reflect investor bullishness about the sector's potential, with market leader SGSSGSN.VX trading at 17.7 times estimated 2011 earnings, at a premium to France's Bureau VeritasBVI.PA at 15.8 and Britain's IntertekITRK.L at 16.6, above the average of 12.2 for the STOXX Europe 600 Industrial Goods & Services index .SXNP.

Shares in Switzerland’s SGS have risen 17 percent this year and Intertek and BV have gained more than 30 percent, outperforming a 13-percent rise in the sector index, but analysts see further upside.

With the oil spill disaster still on everyone’s mind, a new U.S. bill that might compel oil companies to work with third-party testing firms will be high on Congress’s agenda when it returns from summer recess this month.

“At the moment, there are a few large players in the offshore oil market, like Bureau Veritas who has a market share of around 10 percent,” Brunelle said, adding BV would be the big winner if small rivals were not able to keep up with the requirements of a more regulated market and disappeared.

The testing and inspection market is highly fragmented with small niche players active in areas as diverse as commodities testing, consumer products, agricultural, environmental and automotive services, where government bodies are also present.

The trends towards regulation, globalisation and the resulting outsourcing of testing and inspection to specialists are key growth drivers for the three major TIC firms, whose combined sales reached approximately $10 billion (6 billion pounds) in 2009.

“The business area affected by the BP oil spill is the inspection and verification of platforms and the companies set to benefit have to be active in the classification of boats. That is the case for BV, American Bureau of Shipping, Det Norske Veritas (DNV) or Germanischer Lloyd,” said Brunelle.

SGS is also well positioned to benefit from tougher U.S. regulation thanks to its know-how in commodities testing.

“SGS is strong in oil, gas & chemicals services with almost one billion Swiss francs sales (in 2009) and is very active in North America,” Vontobel’s Jean-Philippe Bertschy said.

SGS spokesman Jean-Luc de Buman said it was too early to quantify the positive impact from new U.S. regulation but it would also be felt in SGS’s industrial and environmental units.

BV recently strengthened its position in commodities testing by buying Britain’s Inspectorate for 450 million pounds ($693.2 million) and SGS is also on the prowl for buys.

“SGS would love to enter marine services,” Brunelle said, adding BV was better positioned to buy privately held Germanischer Lloyd, which he said could become a target at some point.

SAFE TOYS

Intertek is not directly involved in testing oil platforms but offers upstream market services such as checking pipelines for corrosiveness and testing crude oil.

“New regulations which surely will come up will help us drive that business,” Intertek Chief Executive Wolfhart Hauser said after the company upgraded full-year revenue forecasts to mid-single-digit growth last month.

Tougher rules are not confined to oil drilling but are expected to spring up in many areas, as reflected in the highly diversified business models of the larger TIC firms.

“You see this trend almost in all sectors, but there is not today one specific new standard boosting the business. Regulation is almost a mindset issue,” said SGS’s de Buman.

TIC firms' sales in consumer products surged last year after the United States adopted the Consumer Product Safety Improvement Act (CPSIA) in reaction to recalls by MattelMAT.O of Chinese-made toys containing lead paint and tiny magnets.

“The CPSIA could be extended to all consumer products,” said Helvea analyst Chris Burger. “But it is a very political issue as the government does not want to burden companies with too many costs at the moment. That could endanger the recovery.”

The European Union’s new toy safety directive, which will come into force in July 2011, will have a positive but less significant impact on consumer product testing than the CPSIA as it will only apply to new toys, meaning there will be no favourable one-offs for the testing of the existing stock.

New European rules that require tyres to be labelled for fuel efficiency, wet grip and rolling noise from November 2012 could push testing firms to bolster their automotive units.

With plenty of new regulation in the pipeline worldwide, analysts now expect SGS to follow its rivals and strike an upbeat note when it presents its 2014 targets in three weeks.

Editing by Sitaraman Shankar

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