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Compass Group - tough first quarter, but in line with plan

Sophie Lund-Yates, Equity Analyst | 4 February 2021 | A A A
Compass Group - tough first quarter, but in line with plan

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Compass Group plc Ordinary 11.05p

Sell: 1,466.00 | Buy: 1,467.00 | Change -21.00 (-1.41%)
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Organic revenue, (which ignores the impact of exchange rates and acquisitions or disposals), fell 33.7% in the first quarter of the financial year. This reflects extended lockdown measures, and was in line with management's expectations.

Revenue is expected to come in at a similar level next quarter.

The shares rose 1.2% following the announcement.

View the latest Compass share price and how to deal

Our View

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.

This all puts serious pressure on margins. It's hard not to be impressed by the cost mitigation efforts from a business perspective, which have stemmed the worst of the margin outflow. If anything, we suspect the crisis has forced Compass to make a lot of long overdue efficiency improvements. But the biggest question now is when we'll be looking down the barrel of meaningful growth again.

Schools and universities need to stay open, and offices need enough hungry mouths inside them for contracts to tick over. As the vaccine roll out gathers pace this should, in theory, feed into a healthier top line. But the speed at which this happens remains something of an unfortunate question mark. We also wonder if the recent backlash around its substandard free-school-meal lunchboxes in the UK will hurt new contract wins or retention.

Compass' broad global customer base, from the Ministry of Defence to luxury watchmaker Patek Philippe, does offer some shelter. While Education and Business sectors are most vulnerable to lockdowns, Healthcare and Military businesses - at the forefront of the pandemic - continue to provide a welcome backstop.

Compass went into the crisis in relatively good shape, and in part thanks to the group's £2.0bn capital raise from shareholders last year, that's still the case. Net debt is higher than we'd like at 2.1 times cash profits at the last count, but isn't yet at an unmanageable level.

The scale of the current challenges shouldn't be underplayed, but we don't think the crisis will prove existential. Strong cost control means Compass should be able to plod along in current conditions, but exactly when sales will kick up a gear is another question. Looking long-term we think a continued trend towards outsourced catering will hold Compass in good stead.

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.

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First quarter trading details

Compass highlighted there had been little volume improvement in the quarter, however, retention rates remain strong, at 95.7%.

Despite the ongoing challenge in volumes, operating margins rose from 0.6% last quarter, to 2.7%. All regions are now profitable, thanks to cost cutting, contract renegotiations and reducing the size of the business.

The Rest of World region was the best performer, with organic sales down 12.3%, compared to 36.7% and 34.6% for North America and Europe. Sports & Leisure was the worst affected sector, with organic revenue falling 76.5%. There were also steep declines in Business & Industry and Education.

The group highlighted it's taken steps to improve the quality of its free school meal food parcels, following the recent backlash.

Compass said the pace of volume recovery remains uncertain, but Q2 operating margins are expected to improve by 0.5 - 1 percentage point. It expects to rebuild margins to 7%, before volumes normalise. The group's indebtedness as a proportion of cash profits will peak at the half year, as expected.

Compass key facts

  • Price/earnings ratio: 33.6
  • 10 year average Price/Earnings ratio: 18.5
  • Prospective yield (next 12 months): 1.5%

All ratios are sourced from Refinitiv. 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.

Find out more about Compass Group shares including how to invest

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 Refinitiv. 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.