Listing shares in London typically attaches a cheaper price tag to a company, no matter how much money it makes overseas. The FTSE 100 constituent Compass Group has bucked the trend, gaining a higher valuation than its international rivals.
A strong bounceback from the depths of the pandemic indicates why the catering giant, which now generates the bulk of its revenue in North America, deserves credit.
Organic revenue growth this year is expected to come in at 18 per cent, above the 15 per cent that Dominic Blakemore, chief executive, guided towards a few months ago. The underlying operating margin is also set to be fatter, at between 6.7 and 6.8 per cent, up from 6.5 per cent.
What does that reflect? Work lost in the pandemic has been fully recovered but it is also winning more new business than anticipated, which should flow through to revenue during the second half of the year. New business, minus contracts lost, contributed just over 5 per cent revenue growth in the first six months of the financial year, above the pre-pandemic rate.
Inflation might be averaging about 9 per cent for Compass, but it is managing to offset that through higher prices, as well as savings that come with greater buying power. The group’s vast scale brings with it operational leverage, which helped push up operating profit more than 40 per cent to £1.05 billion over the first half, outpacing the 25 per cent increase in revenue.
The benefits that come with a tighter focus help explain a superior valuation compared with rivals on international exchanges. An enterprise value of almost 13 times forecast earnings before interest, taxes and other charges is higher than that for the New York-listed Aramark and Sodexo, which trades in Paris. Both these peers also have a finger in activities including uniform supply and property management, alongside catering services. Against Compass’s own history average, the shares still trade at a discount.
The shares have recovered from the heavy losses sustained by the closure of schools and offices in the pandemic, up by almost a third over the past 12 months. The question is whether Compass can sustain the rate at which it is signing new contracts. Of the 18 per cent organic revenue growth expected this year, less than half is set to come from higher prices, which could eventually taper off as raw material and wage inflation eases. About 5 per cent is expected to come from new business and 6 per cent from higher volumes from existing customers.
What’s more, the retention rate is almost 97 per cent, with an average contract length of five years, which gives it a fair degree of sight over future revenue. Compass has a 10 per cent share of the catering market, making it the largest player. But about half the potential market is still self-operated, which means there is plenty to play for, even if the end of post-pandemic comparators means the longer-term organic revenue growth rate looks more like mid-to-high single-digits.
Even after funding the start-up costs of new contracts and spending £210 million on acquisitions, there was enough cash to return £750 million via share buybacks. Once those purchases are completed by the end of this year, net debt will still sit bang in the middle of a target leverage range of between 1 and 1.5 times earnings before interest, taxes and other charges.
A generous valuation might help Compass resist looking west for more capital. It is “happily listed” in London, according to Blakemore, who points out that about 60 per cent of its shareholder register is based overseas. UK investors should hope it continues to resist.
ADVICE Buy
WHY A better rate of new contract wins and the chance to improve the margin further could push the shares higher
Asos
Talk about biting the hand that feeds you. The fast-fashion giant Asos has been attempting to tackle a troublesome cohort of customers: those who are drawn to discounted items yet return a high proportion of what they buy. They might account for only 6 per cent of the embattled retailer’s active customer base but they generate a loss averaging £6 on each order.
Limiting promotions and raising the minimum order value for free next-day delivery offered to these customers has sapped sales. Combined with a pullback in marketing, charging for delivery in some markets, such as the US, and trimming back the number of product lines, the move is responsible for about half of the decline in sales since December.
Sacrificing top-line growth for profitability would be less of an issue if the retailer wasn’t also being dealt a more dramatic blow to sales than anticipated from weaker discretionary spending and a shift back to the high street post-pandemic. Over the three months to the end of February, sales declined 15 per cent. That is not expected to improve any time soon, which puts the group on course for a double-digit fall in sales this year, worse than the consensus expectations of a single-digit decrease.
In October, José Antonio Ramos Calamonte, the new boss, unveiled a survival strategy to reduce stock, slow investment in automation and cut costs. Not before clearing excess stock though, against which Asos took a £128 million write-off, which pushed the group into a £291 million loss. It is aiming to cut back inventory by 20 per cent by the end of August compared with the same point last year. But there could be further charges to come in the second half of the year.
The free cash outflow this year is set to come in at £100 million, the top end of guided losses, even if management is pinning hopes on lower capex and cost savings resulting in an inflow of £150 million in the second half. That all depends on whether sales disappoint again. If so, the next question is whether Asos will be forced to raise more equity to supplement the £400 million in liquidity on its balance sheet.
ADVICE Avoid
WHY The risk of disappointing sales and cash generation later this year is high
