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Three companies with ‘good’ business sense

Nick Hyett highlights three businesses with an ethical and sustainable stance – plus the potential to deliver for investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

When it comes to ethical and sustainable investing, there’s no one size fits all solution. For some it means cutting out harmful goods and services, whilst others look for companies that demonstrate a commitment to gender equality.

But whatever your ethical criteria, it’s important you don’t lose sight of the fact that this is still an investment. You’re looking to own a stake in a company which can grow profits, and ultimately deliver you a good return.

For the purposes of this article we’ve taken membership of the FTSE4Good UK 50 index, as our criteria for an ‘ethical’ investment. The index identifies companies with top Environmental, Social and Governance practices – a positive trait in any company – and we’ve picked a couple we think have particular potential.

Please remember that all investments can fall as well as rise in value, so you could get back less than you invest. Yields aren’t guaranteed or a reliable indicator of what you’ll get in the future.

Ocado

You might think of Ocado as just an online grocer, but it’s much more.

It does have a retail business – although it recently sold 50% to Marks & Spencer – but that’s not where Ocado’s attraction lies. The group’s Customer Fulfilment Centres (CFCs) see robots scurry around a patented grid system. These CFCs are the size of multiple football pitches, and can process hundreds of thousands of orders a week. It’s an attractive proposition for traditional supermarkets wanting to up their online-shopping game and Ocado hopes to sell its technology around the world.


Perhaps counterintuitively Amazon’s entry into online groceries in the US and UK is a positive for the group. A revamped partnership with Morrisons will see the tech giant offer same day delivery to a number of UK cities. A deal with Ocado is perhaps the quickest and easiest way for other retailers to respond to the tanks Amazon is rolling onto their lawn.

But it’s not all perfect. Investors were sold a capital light technology company – and the tech’s there – but Ocado is having to stump up hundreds of millions of pounds to build the CFCs. A bit of a deviation from the more capital efficient licensing model investors might have expected.

And it’s for that reason meaningful profits are some way off. Operating losses are expected to be £92.6m this year. That’s not unusual for fast-growing tech companies, but as yet we’ve had little indication about how profitable new CFC commissions will be. Investing millions for a measly return isn’t an attractive proposition, and new deals have been thin on the ground recently.

Ocado’s a bit of an odd one to value. We’d usually compare earnings per share with the share price, but Ocado doesn’t currently make a profit. Looking at a price to sales ratio the shares change hands for 4.6 times expected sales, way above the long term average. That reflects future potential – widespread uptake of Ocado’s technology could turn the group into a veritable gold mine. However, loss making businesses that promise future riches should always be treated with a healthy degree of caution.

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Intertek

Intertek tests and certifies the quality of a company’s products, processes and people, from children’s toys to clean energy. In clothing, for example, Intertek can work with companies to navigate international standards, ensure supply chains are managed responsibly and that 100% wool is in fact 100% wool.

Increasing regulation, transparency, and investor and consumer concerns about corporate conduct have underpinned increased demand for Intertek’s services. It isn’t only a potential investment for ethically conscious investors, but a beneficiary of the wider ethical investing trend too. We think that’s a pretty sweet place to be.

Quality control requires highly skilled labour and that doesn’t come cheap. On the face of it that’s not great for margins – since each new contract needs new experts. However, dominant market positons and a focus on higher margin acquisitions have delivered steady margin expansion in recent years.

With little capital investment required, the group also generates a lot of cash. That’s good news for investors. Impressive free cash generation funds future expansion, and underpins a new policy of paying around 50% of earnings to shareholders as a dividend. The group’s managed to increase the dividend every year this century, although this isn’t guaranteed to continue.

Of course performances like that don’t go unnoticed in an uncertain economic climate. The stock currently changes hands for 24.1 times earnings, 20.5% above its longer run average. The high rating also means the prospective dividend yield is a relatively modest 2%. We think the rating reflects good growth prospects and resilient revenue streams, but highly rated, acquisitive businesses aren’t without their risks, and a slip could be painful.

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Compass Group

As the world’s largest catering company Compass serves up 15 million meals a day.

Last year the group announced a strategic refresh, which saw sustainability move firmly onto the menu. Alongside profits the group now reports progress against sustainability initiatives too, covering everything from safety incidents, to reductions in food waste and calories.

Contract catering with a healthy twist might not sound exciting, but there are a few reasons the group’s worthy of investors’ attention.

Firstly it doesn’t take a lot of investment by Compass to generate a profit. The group typically uses the client’s existing equipment and facilities so up-front costs are low. Low capital requirements and squeezing benefits from scale mean return on capital employed (ROCE) over time is now standing at 20%.

Keeping invested capital low also means cash flows are healthy and historically have made their way back to shareholders. Compass has grown its dividend every year for almost two decades, and aims to continue going forwards – although there are no guarantees and that relies on continued profit growth against an uncertain economic backdrop.

Fortunately Compass has a geographically and socially diverse customer base. That should smooth all but the worst economic downturns. Moreover the contract catering market looks set to grow. As it stands only 50% of £200bn global food services market is outsourced, with half going to small or local suppliers. Plenty of cake left for Compass to seize.

However, growth is likely to be steady, rather than spectacular. Which means the high rating, a PE (price to earnings) ratio of 22 times earnings, far above its long term average of 16.9, may come as something of a surprise. Reliability in a time of uncertainty comes at a price.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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