On an organic basis (which excludes the effect of acquisitions and exchange rates), group revenue fell 18.8% to £20.2bn. That reflects the impact of business closures because of Covid-19. Lower revenue, coupled with the write-down in the value of some contracts, meant underlying operating profit was £561m (£1.9bn in 2019). However, cash profits were better than analysts had expected.
Compass plans to rebuild underlying margins to 7% before volumes return to pre-pandemic levels. That reflects efforts to reduce costs and improve efficiency, which includes reducing headcount.
The shares rose 4.9% following the announcement.
In normal times, contract catering is attractive. Compass typically uses equipment and facilities owned by the client, so capital requirements are low and returns are strong.
But we're not in normal times. Lockdowns saw half of the business closed, and while more sites are reopening, they do so under strict social distancing rules. A second round of lockdown restrictions in much of Europe adds to this problem.
Higher costs and fewer customers results in serious pressure on margins. To its credit, Compass has broken even on an underlying basis for the first time since the crisis began. That's thanks to hefty cost saving and restructuring efforts.
It's hard not to be impressed by the cost mitigation efforts from a business perspective. If anything, we suspect the crisis has forced Compass to make a lot of long overdue efficiency improvements. But the extent and speed of the group's recovery remains uncertain.
The US and Europe are Compass' most important regions but are also the most exposed to recurring lockdowns until a vaccine is rolled out en masse. Schools and universities need to stay open, and offices need enough hungry mouths inside them for contracts to tick over. We are seeing some positive trends on this front, but the sands are still shifting.
Compass' broad global customer base, from the Ministry of Defence to luxury watchmaker Patek Philippe, should help too. While Education and Business sectors are most vulnerable to lockdowns, Healthcare and Military businesses - at the forefront of the pandemic - continue to provide a much needed backstop.
While the recovery remains rocky, both Compass and investors should 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 still the case. Net debt is higher than we'd like at 2.1 times cash profits, but isn't yet at an unmanageable level, nor is Compass' access to significant liquidity really contingent on keeping debts down.
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 the current challenges shouldn't be underplayed we don't think the crisis will prove existential.
That strength is reflected in the valuation though. Investors should be mindful that the market is expecting a lot from Compass as the pressures of the pandemic ease. The shares will be sensitive to any disappointment.
Compass key facts
- 12m forward Price/Earnings ratio: 34.3
- Average 12m forward Price/Earnings ratio since listing (2014): 18.0
- Prospective yield: 1.2%
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.
Full year results
Group operating margin was 2.9% compared to 7.4% last year. Compass returned to profitability in the fourth quarter as businesses started to re-open and cost saving measures succeeded.
North America (which makes up 63.1% of group revenue) saw organic revenue fall 18.5%, to £12.7bn, reflecting very steep volume declines. Trading was especially restricted in Sports & Leisure businesses, and trends were weak in higher education and Business & Industry. Despite the challenges, retention rates in the region were 96.4%.
Operating profit of £606m was 53.1% behind last year, and operating margins dipped to 3% in the fourth quarter (4.8% for the full year). "Significant" efforts have been made to mitigate the impact of volume declines, including renegotiating contracts, furloughing staff and in some cases, permanently reducing headcount.
Europe was held back by its particular exposure to Business & Industry, Education and Sports & Leisure. Revenue fell 24.0% to £5.0bn. Contract retention remains in line with last year. Operating margins are in negative territory, resulting in an operating loss of £29m. While still subdued, margins did improve in Q4.
Rest of World reported a 7.9% drop in revenue to £2.4bn, and a 51.1% fall in operating profit to £94m.
Globally, Compass has received £437m in government pandemic support so far. It has also re-evaluated its staffing levels, and redundancies will result in annual savings of £280m. The resizing efforts and previously announced cost actions cost Compass £197m this year.
Lower profits fed into free cash flow of £213m, compared to £1.2bn in 2019.
Net debt was £3.0bn at the end of September, compared to £3.3bn at the same time last year. That reflects the proceeds from the equity raise, which offset lease costs. Lease debt contributed £995m to net debt.
Including the leases, net debt is equivalent to 2.1 times cash profits. Compass would like to lower this to 1.0 - 1.5 times.
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