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Compass Group - Sales solid, but work needed on cost

Nicholas Hyett | 26 November 2019 | A A A
Compass Group - Sales solid, but work needed on cost

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Compass Group plc Ordinary 11.05p

Sell: 1,494.00 | Buy: 1,495.00 | Change 31.50 (2.15%)
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Compass reported a 5.7% increase in full year underlying revenues at constant currency, reaching £25.2bn. Operating profits rose 4.7% to £1.9bn.

A final dividend of 26.9p took the full year payment to 40p, 6.1% ahead of last year.

However, CEO Dominic Blakemore warned that the group "remain cautious on the macro environment in Europe" and cost saving action is expected to result in £300m of exceptional costs across this year and next.

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Our View

Contract catering is intrinsically attractive. Since Compass typically uses equipment and facilities owned by the client, capital requirements are low and returns are strong. The result is a return on capital employed of nearly 20%.

That helps has helped generate healthy cash flows, which have in turn seen the group grow its ordinary dividend every year since the start of the century. 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, and management are cautious about the future, especially in Europe. Lower consumer spending spending confidence and higher costs are denting performance, and remedial action is proving unexpectedly expensive.

The additional cash costs of the restructure are expected to pay for themselves over two years, so while they're less than ideal we're not overly concerned by them - especially since Compass has an excellent track record on driving efficiency.

More concerning in our view is the write down of contracts the group now see as 'structurally loss making' in a tougher economic environment. Underpricing contracts to win business has been the bane of many an outsourcer, and while there's no evidence that this is a systematic problem at Compass Group it's something we will be keeping a close eye on.

Longer term, demand for Compass' services is has been 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 the Ministry of Defence to luxury watchmaker Patek Philippe means revenues should prove resilient. The group is also targeting margin gains through its Management and Performance plans, which seeks to minimise unit costs.

There aren't many stocks that can match Compass' record of dividend growth and offer the prospect of additional capital returns. That's reflected in the share price though, with the prospective dividend yield at 2.1% and a price to earnings ratio of 22.5. That's well above the long run average of nearer 17. But when shares are priced at a premium, as Compass' are, even the smallest slip can startle the market, with potentially painful consequences.

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Full year results (constant currency)

Underlying revenue growth was driven by a very strong performance in North America, with growth of 8.5%. The region accounted for 62.4% of total revenues, and benefitted from significant structural growth as 40% of new business derived from first time outsourcing. Regional operating profits rose 9% to £1.3bn.

Europe saw underlying revenues rise 1.6% (accounting for 23.3% of group total revenue). However underlying operating profits fell 6.6% to £368m as the group faced cost inflation and negative sales mix. Rest of World sales were broadly flat year-on-year at £3.6bn, with operating profits rising 5.9% thanks to improved efficiency and pricing.

Revenues benefited from £478m of bolt-on acquisitions during the year, mostly in North America, with further acquisitions in the pipeline. Disposals of non-core business continues.

Organic revenue growth next year is expected to be around the middle of the 4-6% range. Margins are expected to remain strong as efficiency programmes offset lower volumes.

Free cash flow rose 9.3% to £1.2bn. That supported a slight decline in net debt to £3.3bn, which amounts to 1.3 times cash profits.

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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 for more information.