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Compass Group - Q2 still weak, cost control helping margins

Sophie Lund-Yates, Equity Analyst | 25 March 2021 | A A A
Compass Group - Q2 still weak, cost control helping margins

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Compass Group plc Ordinary 11.05p

Sell: 1,704.50 | Buy: 1,705.00 | Change 56.00 (3.41%)
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Compass Group expects to report a fall of around 31% in first half organic revenues. That reflects continued declines in all markets, most noticeably in North America and Europe, although performance has improved slightly from the first quarter. Business & Industry and Sports & Leisure are the worst affected sectors, down around 42% and 73% respectively.

Despite continued volume weakness, operating margins improved in the second quarter thanks to cost savings and are expected to come in at around 3.4%. Compass is still confident it can rebuild these to 7% even before returning to pre-pandemic volumes.

The group said "the pace of volume recovery remains uncertain", but that new business and client retention are "strong". More detailed numbers will we released on 12 May 2021.

The shares rose 1.5% 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 have decimated the business, with workplace cafes, school canteens and sports stadium outlets all a distant memory for many.

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 and mean the group is still in the black at the operating profit level. 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 at 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.

Compass' broad global customer base, from the Ministry of Defence to luxury watchmaker Patek Philippe, does offer some protection. 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.

The other piece of good news is that client retention and new business wins appear to be holding up well. Clearly end-customers still expect workers and customers to return at some point, and there's appetite for Compass' market leading offer.

Compass went into the crisis in relatively good shape. That didn't stop it seeking an emergency £2.0bn capital raise from shareholders last year, but also means net debt is only 2.1 times cash profits despite the collapse in sales. That's higher than we might like but isn't an unmanageable level.

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

Overall, Compass remains an attractive business. If the group's able to get sales back to last year's level, and come good on their 7% margin target, the share price valuation isn't as demanding as it seems. Still there's a lot of pressure to deliver in the short-term, as the pandemic eases.

Compass key facts

  • Price/earnings ratio: 33.8
  • 10 year average Price/Earnings ratio: 18.8
  • Prospective yield (next 12 months): 1.6%

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.

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First quarter trading details (4 February 2021)

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.

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 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.

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.