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Compass Group - better than expected Q4

Sophie Lund-Yates, Equity Analyst | 21 September 2021 | A A A
Compass Group - better than expected Q4

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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's fourth quarter revenue was better than expected, reaching about 86% of pre-pandemic levels. The improvement was led by Sports & Leisure, as more people attended outdoor sports. Healthcare and Defence, Offshore & Remote are all trading ahead of 2019 levels.

Underlying operating margins are expected to be at the mid-point of the 5.5% - 6.0% guidance range in the fourth quarter, and 4.4% for the full year.

The group "remains cautious" about recovery in the Business & Industry division, but is confident of returning to a group operating margin of 7% before reaching pre-pandemic volumes. More detailed results and guidance are expected on 23 November 2021.

The shares were unmoved following the announcement.

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Our View

Contract caterer Compass relies on large groups getting together. That made lockdowns and social distancing the stuff of nightmares. But Compass is pointing in the right direction. Fourth quarter revenues were starting to catch up to pre-pandemic levels, as more of us ventured out to watch live sport.

An impressive focus on cost savings also means margins - while dented - didn't completely collapse during lockdowns. If anything, we suspect the pandemic forced Compass to make a lot of long overdue efficiency improvements. And those are paying off now that sales are starting to recover. The group looks to be emerging from the crisis stronger than it went in - it intends to restore margins to above 7% before volumes fully recover.

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. Everyone needs to eat.

But schools and universities will need to stay open, and offices need enough hungry mouths inside them for contracts to tick over. The Covid-related shift to working from home could be permanent, at least in part, so it remains to be seen how and when the group will restore volumes to 2019 levels. We note that client retention's held up well, so there is optimism that life will return to normal, but it's too soon to call exactly if, or when, this will happen.

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 disruption, Healthcare and Military businesses continue to provide a welcome backstop.

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 at last check, it stood at 3 times cash profits. That's despite a pause in spending on new business initiatives and pared down spending in other areas. 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.

Overall, we think Compass is an attractive business, and the pandemic has actually strengthened it in some ways. But the group's above-average valuation takes this into account. That's fair if things go to plan, but another bout of lockdowns or a slower than expected sales recovery could cause volatility.

Compass key facts

  • Price/earnings ratio: 24.7
  • Ten year average Price/earnings ratio: 19.7
  • Prospective dividend yield (next 12 months): 1.9%

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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Third quarter trading details (29 July 2021)

Third quarter organic revenue rose 36.4%, as the Education and Business & Industry segments recovered ''gradually'' from Covid-related disruption, and the Sports & Leisure business benefitted from higher attendance in North America. A focus on cost management also helped third quarter margins improve to 5% from 4.2% in the second quarter.

The Heathcare & Seniors and Defence, Offshore & Remote businesses continued to deliver sales beyond pre-Covid levels. Education sales in the third quarter were 77.7% of those in 2019 and Business &Industry and Sports & Leisure recovered to 60.8% and 48.7% of 2019 levels respectively.

Despite the strong quarter, total organic revenue so far this year is still down 16.1%.

Third quarter sales in North America were 36.1% ahead of last year's, but weakness in the first and second quarter meant total revenue so far this year is still down 18.2%. Margins continued to improve, settling at 5% year-to-date.

Trading in Europe improved with third quarter margins gaining more than 2 percentage points to 3.8%. Revenue rose 46.1% in the quarter, but so far this year sales are down 17.9% overall.

Rest of World saw sales rise 22.4% in the third quarter, nearly offsetting weakness in the first half of the year. Margins rose to 5.7% in the third quarter from 5.4% in the second.

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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.