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Compass Group - trading challenging, but reopening on the menu

Emilie Stevens, Equity Analyst | 30 July 2020 | A A A
Compass Group - trading challenging, but reopening on the menu

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Compass Group plc Ordinary 11.05p

Sell: 1,728.00 | Buy: 1,729.00 | Change 48.00 (2.86%)
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Group organic revenue fell 44% in the third quarter, and is 14% lower over the first 9 months of the year. That reflects a quarter over which lockdown measures were most severe in many of Compass' markets.

Management said performance was good in the Healthcare and Defence, Offshore & Remote divisions, but the Education and Business & Industry sectors were mostly closed over the quarter.

By the end of June, about 60% of the business was open, compared to 55% by the end of May. However, despite progress in June the pace of recovery is still not clear to the group.

The shares fell 3% following the announcement.

View the latest Compass share price and how to deal

Our View

In normal times, contract catering is attractive. Since Compass typically uses equipment and facilities owned by the client, capital requirements are low and returns are strong.

But we're not in normal times, coronavirus "has changed everything". Around half of the business was closed due to lockdowns and while more sites are opening, they do so under strict social distancing rules. Higher costs and less customers have been putting serious pressure on margins. Compass is confident at the moment it can pass costs on to customers, but we'll wait to see how the re-negotiating goes.

Fortunately Compass has a broad global customer base that ranges from the Ministry of Defence to luxury watchmaker Patek Philippe. So while declines in Education and Businesses sectors have been significant, Healthcare and Military businesses - at the forefront of the pandemic - have provided a much needed backstop.

If the recovery continues to be slow and sales, particularly in the Business sector, still suffer - profits will continue to take a hit. How hard depends on how long the disruption lasts, if Compass is successful in renegotiating contracts and continues to keep non-essential spending down.

At the start of the crisis Compass was quick to react and knocked a sizeable chunk off monthly costs. Some input costs, like stock and temporary staff, are proving reasonably easy to tweak, but other costs are less flexible.

Which means both Compass and investors continue to look to the balance sheet for resilience.

Compass went into the crisis in relatively good shape and in part thanks to the group's £2.0bn capital raise from shareholders earlier this year, that's roughly still the case. Net debt is £3.2bn, down from £4.9bn in March. And while it's still higher than we'd like, it isn't an unmanageable level nor is Compass' access to significant liquidity really contingent on keeping debts down. The group's significant liquidity provides important breathing room too.

Over the longer term, we think demand for Compass' services will continue to be driven by both economic growth and the ongoing trend toward greater adoption of outsourced catering solutions. While the scale of current challenges shouldn't be underplayed we don't think the crisis will prove existential for Compass.

Compass key facts

  • 12m forward Price/Earnings ratio: 24.4
  • Ten year average 12m forward Price/Earnings ratio: 17.5
  • Prospective yield: 1.6%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Results

Reopening sites in line with health and safety protocols and lower attendance is more costly and Compass is entering into contract re-negotiations with clients to cover these costs. However, despite this work operating margins were -6.3% in the quarter, down from 6.2% at the half way mark.

North America (69% of 2019 profits) saw revenues drop 45% in the quarter and operating margins were -3.1%. However, the region benefitted as state level lockdown restrictions allowed more sites to stay open than in Europe. Compass is talking to clients about the higher cost of operating in coronavirus, which combined with more flexible labour laws, has allowed it to adjust its cost structure and start to rebuild the operating margin.

Europe (20% of 2019 profits) revenues dropped 54% and operating margin fell to -14.5%, reflecting the regions higher weighting in Business & Industry and lower Healthcare exposure. While sites are starting to reopen and Compass is again working to pass on higher costs to clients, progress in Europe is expected to be slower.

Rest of World (15% of 2019 profits) revenues were down 20% with a positive operating margin of 3.1% - reflecting higher exposure to Offshore & Remote which has not been as severely impacted by lockdowns.

Compass saw a free cash outflow of £260m in the quarter, which included £130m in already committed capital expenditure.

Net debt was £3.2bn at the end of June. The £2 billion in cash from May's equity raise was used to repay £600 million of the Bank of England's COVID Corporate Financing Facility (CCFF), repay £201 million drawn credit facilities and repay £42 million maturing short term debts. Compass's total liquidity is £5.0 billion (£2.8 billion in undrawn credit facilities, £600 million available CCFF limit and £1.6 billion in cash).

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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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