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Compass Group - margin recovery on track

William Ryder, Equity Analyst | 12 May 2021 | A A A
Compass Group - margin recovery on track

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Compass Group plc Ordinary 11.05p

Sell: 1,941.50 | Buy: 1,942.50 | Change -0.50 (-0.03%)
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Compass Group reported underlying revenue of £8.6bn, a 30.4% decline from the previous year and in line with internal expectations. That reflected double-digit losses across most of the group's divisions with Defence, Offshore & Remote and Healthcare & Senior Living reporting minor organic sales increases.

Operating margins for the first half were in line with expectations at 3.4%. Between January and March, the group's underlying operating margin was 4.2%, more than half of pre-Covid levels despite lower trading volumes.

The current trading period is expected to deliver gradual revenue improvements with underlying operating margins between 4.5% and 5%. The group still expects to restore underlying margins to above 7% before volumes return to pre-Covid levels.

The shares were broadly flat 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 decimated the business, and while a recovery is materialising, it mirrors the slow and patchy return to normalcy we're seeing around the world.

The pandemic put margins under pressure, but management's deft cost mitigation efforts stemmed the worst of the margin outflow and meant the group remained in the black at the operating profit level throughout the crisis. If anything, we suspect the pandemic 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 revenue 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. Progress has been slow on this front, so it remains to be seen how quickly we can expect volumes be restored to some semblance of normalcy.

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 are 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. But debt levels have been ticking uncomfortably higher. While the group managed to reduce its net debt position, the collapse in sales means it stands at 3 times cash profits--an uptick from 2x at the same time last year. That's despite a pause in spending on new business initiatives and pared down spending as client locations remain closed. Management will need to toe a narrow line to keep liquidity in check as it loosens the purse strings to keep up with returning demand.

The scale of the current challenges shouldn't be underplayed, but we don't think it will prove existential. Strong cost control means Compass should be able to plod along in current conditions, and a continued long term trend towards outsourced catering should stand the group 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: 33.5
  • 10 year average Price/Earnings ratio: 19.1
  • 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.

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First half trading details (all figures reported on an organic basis)

Underlying revenue in North America (60.4% of group revenue) declined 32.8% to £5.2bn as a result of continued Covid-related volume declines. Compared to the fourth quarter, sales were up 6%, reflecting the limited return of spectators at some sporting events and double-digit growth in the Healthcare & Senior Living division. The Business & Industry and Education divisions continued to see patchy recoveries. A focus on cost control meant margins rose to 4.7%. Underlying operating profits fell 60.6% to £245m.

Volumes in Europe (26.4% of group revenue) were unchanged for the second half of 2020 as lockdowns across the region weighed on trading. Underlying revenue declined 32.8% to £2.3bn while profits fell 83% to £32m. New business growth surpassed 5%, driven by the UK and Turkey and retention in the region improved slightly from 2020 levels to 93.5%.

Trading in the Rest of World (13.2% of group revenue) was the most resilient of the group's divisions, primarily because of its exposure to Defence, Offshore & Remote and Healthcare & Senior Living segments. Revenue of £1.1bn was roughly 82% of 2019 levels and down 9.4% from 2020. Double-digit new business growth in Australia and Chile was a key driver, but was offset by Covid-related volume declines elsewhere. Underlying operating profit was down 22.1% to £53m.

Underlying free cash flow rose £173m to £359m, reflecting a focus on cash management as well as reduced capital expenditure due to delayed client openings and postponed new business initiatives.

Net debt fell to £2.6bn from £3bn in 2020 and now stands at 3.0 times cash profits compared to 2.0x at the same time last year.

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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 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.