Compass Group (CPG) started life in 1941 as Factory Canteens Limited. Although the rather corny-sounding name was soon dropped, the hospitality company is still known as a solid but bland investment opportunity. However, as the recession approaches, the group – with its handful of new contracts, global presence and loyal client base – is looking increasingly attractive.
Bull points
- Record deals win
- A resilient mix of clients
- Good free cash flow
- Investing in growth
Bear points
- Margin pressure
- Office catering in doubt
Compass provides food for offices, schools, hospitals, nursing homes, gyms and large event venues. So it’s no surprise that the FTSE 100 company has been hampered by Covid-19. However, the damage appears to be temporary: revenue has now surpassed pre-pandemic levels and momentum is building. In the year to 30 September 2022, the group won a record £2.5bn of new business, up from £2.1bn in FY2021 and £1.9bn in FY2019.
Overall, net new business grew 5.7 percent compared to pre-Covid levels, significantly higher than Compass’ historical growth rate of 3 percent. Existing clients are also satisfied: client retention reached a new record of 96.4 percent last year. These indicators contributed to cheerful forecasts for the coming year. In this financial year, organic revenues are expected to grow by 15 percent, while basic operating profit is on track to increase by more than a fifth.
Catering for masses
Compass’s confident outlook is not entirely intuitive. The hospitality sector has been vocal about its struggles with inflation, labor shortages and a cost-of-living crisis, with rail strikes making the situation worse. However, Compass is unlikely to benefit from some of these issues. The client’s “operational complexity and inflationary pressures … are driving increased outsourcing, and we are successfully capitalizing on the resulting growth opportunities,” CEO Dominic Blakemore said in November.
In other words, companies struggling to feed their staff, patients and students want to shift the problem onto someone else. The group’s full-year results confirm this: clients who have not previously used outsourcing accounted for around 45 percent of new business in 2022.
While this increase in demand may begin to normalize as economic pressures ease, some lasting changes also appear to have occurred. Citi analyst Leo Carrington suggests that the healthcare and education sectors in North America “have historically been averse to outsourcing” but have, for example, been turned to their strengths during the pandemic.
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The popularity of contract caterers is visible elsewhere. European rival Sodexo (FR:SW) reported a strong start to 2023 this month, with organic revenue up 12 percent and further improvement in client retention. Analysts are relaxed about potential competition, claiming that large restaurateurs like Sodexo and Aramark (US:ARMK) they enjoy slices of the bigger pie, as opposed to stealing each other’s work.
This does not mean that the customer bases of smaller companies are not in the crosshairs. Around a quarter of the £220bn global foodservice market is currently in the hands of regional players. However, the economic turmoil – which followed numerous quarantines – favored those with more muscle.
“Post covid, we’ve seen a real pick-up among the big boys,” said Vicki Stern, managing director and leisure research analyst at Barclays. “They obviously have advantages of scale, but there are also digital and environmental, social and governance (ESG) factors that support the larger operators. And the small operators, from a financial point of view, may be in less good shape. This has polarized the difference even more between big and small.”
To canteensndrum
The obvious chink in Compass’s armor is its Business & Industry (B&I) division, which specializes in workplace hospitality. Homework is clearly a threat to office canteens, and many management teams are under pressure to cut unnecessary costs. During the November earnings report, analysts were particularly concerned about the beleaguered tech sector, whose fast-growing companies until recently offered employees everything from free sushi to ice cream.
Things don’t look too bleak, though. Although B&I’s underlying sales in FY 2022 fell 9 percent from 2019, they rose 6 percent in the latest quarter. Moreover, the group relies less on office catering than it did during the last financial crisis. In 2009, 46 percent of revenue came from B&I. Last year, the division generated just a third of sales, with health care and senior living playing a larger role, leading management to estimate that roughly half of revenue now comes from non-cyclical sectors.
Demand therefore looks quite robust. But what about profitability? Compass’s operating margin has been under severe pressure for the past three years. While it was a comfortable 7.4 percent in 2019, it fell to just 2.9 percent in 2020, before rebounding to 6.2 percent in 2022. Management expects it to recover to “above 6.5 percent” in 2023. , but before the pandemic, profitability is still far away.
However, it is important to pinpoint the source of margin pressure. Food and wages obviously play a role – particularly in the UK – although Compass can be flexible with its menus and deploy staff to different locations. However, management estimates that only 40 percent of the margin impact is due to inflation. Another 40 percent refers to new business gains.
According to Chief Financial Officer Palmer Brown, the new business is cutting into margins in two ways. First, initial mobilization costs are high, as contracts may require new facilities and equipment. Second, it takes some time for the group to reach peak efficiency, which means contracts are more expensive in the first few years. If pushed, Blakemore said the group was committed to “balanced strong top-line growth across the business because we think that’s the most important thing”.
Reasonable Caution
This does not mean that the group is careless. Indeed, when it comes to capital allocation, management has been extremely prudent, saying it does not want to increase leverage more than 1.3 times. As a result, some analysts were disappointed with the £250m share buyback announced last November and hope that more money will be returned to shareholders after half a year. Management, “aware of some uncertainties on the horizon,” wants not to overpromise or overstretch its cash flows.
This approach seems reasonable, especially when you consider the capital expenditures (capex) needed to meet demand growth and new business gains. Capex was low in FY 2022, at just 2.7 percent of underlying revenue. But it is expected to rise to 3.5 percent of underlying revenues in 2023, which is likely to eat into the group’s operating cash flow.
Ultimately, however, Compass looks well-positioned to enter 2023. With or without capital investment, it is highly cash-generating, and global demand for quality caterers is high. It is also possible that in the second half of the year, inflation will slow down and client spending will improve. If that happens, Compass’ profits would get a welcome boost, not least because a delay in contract changes could mean customers continue to pay higher prices in the short term.
Above all, Compass has the rare advantage of operating in 2023 where client demand is growing, margins are recovering and increased capital spending makes sense for a highly experienced management team. This is why the share price, at less than 20 times earnings from FY 2024, is more than acceptable.
| company details | Name | market cap | Price | 52 weeks of Hi/Lo |
| Compass (CPG) | 33.3 billion pounds | 1900 BC | 1971p / 1494p | |
| Size/Length | NAV per share* | Net cash/debt(-) | Net debt / Ebitda | Op cash/ Ebitda |
| 337 p | -2.89 billion pounds | 1.3x | 86% |
| Value | Fwd PE (+12 months) | Fwd DY (+12 months) | FCF yld (+12 months) | P/Sales |
| 22 | 2.3% | 4.1% | 1.3 | |
| Quality/Growth | EBIT margin | ROCE | 5 year sales CAGR | 5 year EPS CAGR |
| 5.7% | 14.5% | 2.5% | -2.6% | |
| Forecasts/ Momentum | Fwd EPS grth NTM | Fwd EPS grth STM | 3 months mom | 3-month EPS change % |
| 27% | 14% | 5.0% | 4.2% |
| End of the year, September 30 | Sales (billion pounds) | Profit before tax (billions of pounds) | EPS (p) | DPS (p) |
| in 2020 | 20.2 | 361 | 18.6 | 0.0 |
| in 2021 | 18.1 | 673 | 29.5 | 11.9 |
| in 2022 | 25.8 | 1,486 | 63.0 | 30.6 |
| Forecast 2023 | 30.6 | 1,928 | 84.5 | 41.5 |
| Forecast 2024 | 32.8 | 2,260 | 96.9 | 47.5 |
| Change (%) | +7 | +17 | +15 | +14 |
| Source: FactSet, adjusted PTP and EPS figures | ||||
| NTM = next 12 months | ||||
| STM = Another 12 months (ie one year from now) | ||||
| *Includes intangible assets of £7.1bn or 404p per share | ||||