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Compass Group - an encouraging start to the year

Emilie Stevens, Equity Analyst | 6 February 2020 | A A A
Compass Group - an encouraging start to the year

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Compass Group plc Ordinary 11.05p

Sell: 1,192.00 | Buy: 1,193.50 | Change 0.00 (0.00%)
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Underlying revenues grew 5.3% over the last three months of 2019. This reflects strong new business levels and good client retention, particularly in North America.

After an "encouraging" start to the year, Compass still expects revenues for the full year to grow 4 - 6%, whilst maintaining margins. The plan to save £300m in costs over the next two years is said to be progressing well.

The shares rose 2.8% in early trading.

View the latest Compass share price and how to deal

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 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 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 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 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 2.3% and a price to earnings ratio of 21.2. That's well above the long run average of nearer 17.

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First quarter trading update (constant currency)

North America, which made up 62% of total revenues last year, saw revenues rise 7.5%.That reflects particularly strong growth in Business & Industry, Healthcare and Education divisions.

In line with Compass' expectations, in Europe, which accounts for just over 23% of group revenue, revenues remained flat year-on-year. This reflects lower volumes in Business & Industry and a quieter Sports & Leisure calendar, partially offset by good performance in Turkey and Central and Eastern Europe.

Rest of world, which makes up 14% of total revenues, saw revenues rise 4.7%, reflecting growth in Australia and Latin America.

Compass spent £40m on acquisitions in the quarter and, with approval from the EU Competition Commission, completed its cash purchase of Nordic caterer, Fazer Food Services, for around EUR420m.

As part of the ongoing disposal programme, Compass recently sold half of its Japanese Highways business for £55m and has agreed to sell the remainder over the next three years.

Find out more about Compass Group shares including how to invest

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.

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