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Compass - Serving up steady growth

Nicholas Hyett | 28 November 2017 | A A A
Compass - Serving up steady growth

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Compass Group plc Ordinary 11.05p

Sell: 1,528.00 | Buy: 1,529.00 | Change 17.50 (1.16%)
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Updated 02/01/2018

Compass CEO Richard Cousins was killed in a plane accident on 31st December. The appointment of Dominic Blakemore, formerly COO Europe, as Chief Executive has been advanced from 1 April 2018 to 1 January 2018.

Compass benefitted from sterling weakness over the full year, boosting reported profits significantly. On an underlying basis, full year revenues rose 4% to £22.9bn, with operating profits up 5.6% to £1.7bn following a 0.2 percentage point improvement in operating margins. The annual dividend rose 5.7% to 33.5p per share.

The shares fell 2.1% in early trading.

Our View

Contract catering is an intrinsically attractive business. As Compass typically uses equipment and facilities owned by the client, little capital has to be invested and returns can be strong. Compass has a return on capital employed of over 20%.

Low capital requirements help generate healthy cash flows, which have in turn helped the group grow its ordinary dividend every year for over a decade. Compass has also paid significant sums in share buybacks and special dividends, although of course there are no guarantees this will continue.

The group is generally performing well, with organic growth in most areas. But there are weak spots.

'Remote & Offshore' supplies mining and oil companies, and they have pulled in their horns as lower commodity prices hit home. Restructuring the division cost Compass £51m over the last two years, but that process is now at an end, and margins are rebounding as a result.

Long term demand is driven both by economic growth and the ongoing trend toward greater adoption of outsourced catering solutions, which has seen substantial increases in the addressable market.

A broad customer base that ranges from Aston Villa to De Beers in South Africa and Verizon in the US means revenues should prove resilient. The group is also targeting margin gains through its Management and Performance (MAP) plans, which seeks to minimise unit costs.

The stock currently offers a prospective dividend yield of 2.3% for 2018 and trades on 20.1 times forward earnings estimates. That's above its long run average of nearer 15x, but there aren't that many stocks that can match Compass' record of dividend growth, and offer the prospect of additional capital returns over time.

Full Year Results

Compass served up 7.1% revenue growth in North America, which now accounts for 58.3% of group. Underlying operating margin in the region remained unchanged at 8.1%, with profits of £1.1bn. The strong performance reflects good new business wins and a 96% retention rate.

Europe, 25.9% of group revenue, saw revenues creep up 1.6%. At a steady margin of 7.2%, this resulted in operating profits of £428m. That follows good progress on new business in the UK and Turkey, partly offset by dull trading on the continent, principally France and Germany.

Rest of World, Compass' smallest division at 15.8% of group revenue, saw revenues slide 2.5% - although a slight improvement in operating margins helped profits rise to £248m.

Excluding the Offshore & Remote business, Rest of World organic revenues would have grown 3%, with headwinds in the sector also weighing on performance in North America and Europe. The rate of organic revenue decline has slowed in the second half, with restructuring costs in the sector now dropping out of the income statement.

Net debt at the end of the year stood at £3.4bn, around 1.6 times EBITDA (earnings before interest, tax, depreciation and amortisation). This is slightly above the group's target 1.5 times following the £1bn special dividend paid at the half year. Free cash flow in the year rose 7.3% to £974m.

The group expects revenue growth and margin improvements in FY 2018 to be weighted towards the second half once again.

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 for more information.