Compass Group PLC
LSE:CPG
Earnings Call Analysis
Q3-2023 Analysis
Compass Group PLC
The company has maintained a robust financial health through the recent quarter, demonstrating an impressive 15% organic revenue growth and 21% year-over-year. These robust results are broadly spread across all regions, underpinned by effective pricing, and strong volume growth, while navigating the post-lockdown era. Moreover, the company has maintained an outstanding client retention rate of 96.7% and boasts a promising pipeline for future growth.
Inflation has been a persistent obstacle, however, the company has strategies in place to mitigate its impacts. Despite observing food inflation peaking, with signs of easing in some areas, the company anticipates the overall basket of cost inflation will remain above CPI. Executives are confident in their ability to manage these headwinds through effective mitigation and smart pricing strategies, which in turn, strengthens their competitive edge, particularly in comparison to High Street offerings.
The executive team has reaffirmed the existing full-year guidance, projecting continued strength in the company's performance. There is an expectation of sustaining mid to high-single-digit organic growth along with incremental margin progression. This is anticipated to lead to profit growth surpassing revenue growth, ensuring that investors can expect compounding returns on their investment over time.
The company has been transparent about the pressures caused by prolonged heightened inflation. While there has been a 'reset' in the cost base resulting in margin impacts, the company does not expect to recover the full 100 basis points lost. Yet, there's a clear pathway back to pre-COVID margin levels which, combined with the current new business rate of £2.5 billion ARO, forms the basis for optimism in the company’s future profitability.
The US market, while facing logistics challenges such as strikes and potential bankruptcies, particularly in the healthcare sector, is being proactively managed by the company. Interestingly, such turmoil has not significantly impacted the business due to the company’s vigilant management approach. The debtor aging profile has evolved in the US, influenced by business mix changes and higher growth rates in Europe. This proactive approach facilitates the company's resilience in a market marked by increased financial pressure across sectors.
Even though complete segregation of volume growth contributors within a quarter is complex, the executives acknowledged redevelopment benefits particularly in Europe. A positive trend is seen in office attendance and participation rates despite headwinds from redundancy programs seen in tech and other sectors. Contract renegotiations borne during the pandemic have reaped significant goodwill, which further reinforces their client retention strategy. The focus on improving operations, especially in Europe, has culminated in remarkable retention rates—which they believe can be further improved upon.
The company's sports and leisure sector in North America sustains strong performance with consistent consumer spending. Although it's facing the comparable high activity from the second half of the previous year, this has not hampered its robust growth in revenue. Moreover, the company anticipates this financial year to set new records in new business wins—augmented by an improving pipeline and increased contract conversion rates—an indicator of the company's successful expansion in these demanding market segments.
The balance sheet reflects judicious capital allocation, balancing between CapEx, M&A, and shareholder returns, with expected CapEx at the lower end of 3% for the full year. The target leverage ratio is expected to hit the midpoint range by year-end, coinciding with the current £750 million buyback completion. The company manages the balance sheet with an acute awareness of the current interest rate environment and focuses on maintaining financial robustness during unpredictable market conditions.
Finally, while the nature of inflationary pressures has changed the margin profile, the company is seeing a normalization in startup costs and mobilization, reducing the drag on margins. Executives remain fully committed to investing in global capabilities, digital transformations, and talent acquisition to ensure sustainable long-term growth. Despite the challenges posed by the inflationary environment, the company is on track to achieve nearly 7% margins in the second half, signaling true progress and strong management confidence in the overall business performance.
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Good morning, everyone. And thank you for joining us. As usual, I'm here with Palmer, our CFO. We've had another good quarter, with strong organic revenue growth of 15% and 21% year-to-date. This reflect net business growth nicely balanced across all of our regions, the right levels of pricing and strong like-for-like volumes and, of course, this is despite lapping the full reopening of our sectors last year.
Our client retention rate remains excellent at 96.7% and we have an exciting pipeline of new business opportunities across all of our regions.
Despite persistent inflationary pressures, we're encouraged with our margin progress. Food inflation appears to have peaked and is easing in some regions, but we expect our basket of cost inflation to be above CPI and historic levels for some time to come. We're well placed to manage this with mitigation and sensible pricing, whilst increasing our competitiveness relatively to the High Street. And of course, these cost pressures accelerate outsourcing.
We're very pleased with the continued strong momentum and performance of the group, and we reiterate our full year guidance. Longer term, we expect these growth opportunities to sustain mid to high-single digit organic growth and incremental margin progression, leading to profit growth above revenue growth.
Our proven value creation model will continue to reward shareholders with compounding returns.
Let's now move to Q&A.
[Operator Instructions]. Now the first question comes from Jarrod Castle from UBS.
I'll ask the normal three. You said that cost pressures are helping outsourcing, but I'd also like to just get some color if you're still seeing customers being attracted more to the larger players in contract catering in terms of consolidating around the larger players rather than the regional smaller players.
And then two questions just around margin. Obviously, the Americas' very tough base effect is delivering low organic growth to other geographies. That's going to obviously have a mix impact on your margin, given it is your highest margin business. How do you see the ability to offset that, given rises in both rest of the world, maybe in North America and obviously Europe?
And then just linked to, I guess, your goal of getting back to previous margin levels, any view on kind of timeframes? Or is this just going to be dependent on kind of the organic growth you deliver?
Let me have a go [Technical Difficulty] Palmer then add some color to each and take the second question. First of all, in terms of your question around cost pressures and whom it most impacts, if you take a step back, we believe that at a time like this with significant inflationary pressures and the complexities of operating in this environment that we've signaled for a while, the benefits of scale are very significant. Now that applies, first and foremost, to self op where those pressures are our most keenly felt, but equally applies to smaller players that don't have the benefits of our buying power, our ability to manage menus at scale and so forth. And so, yes, we do believe that it's creating opportunity for us. Again, really, both in the first time outsourcing opportunity and with the small players. And we think that is set to continue with the sorts of inflationary levels that we anticipate for a while yet, as you heard me say.
In terms of the margin levels, I think what's really important is we now need to focus as much on profit growth as we have on margins. We're growing profits significantly above the levels that we did pre-COVID. We believe that our revenue growth is going to accelerate into the range we've discussed on a sustainable long term basis and that our profit growth will be above that, with incremental margin progression. So we've always said there's nothing to hold us back from getting back to the pre-COVID margin. We're very focused on that accelerated profit growth. And really seeing margin as the outcome of that.
I think it's also fair to say, and I'm sure Palmer will touch on it, with the level of cost inflation that we've absorbed and by doing the right thing vis-a-vie our clients, which is to price with the net cost inflation without pricing for margin on that, that represents a margin drag that we've had to offset. So, really, there's been a bit of a reset within our margin structure, and therefore, we're super focused on the profit growth as the right KPI for the business going forward.
Just some color on the last point before I get to your question on North America, Jarrod. On the cost inflation, in the past year, we faced over a £1.5 billion of inflationary pressures on our call space. It's over £3 billion over the last two years. This year, we have been able to keep our unit margin flat, facing those inflationary pressures. That comes from massive mitigation efforts, massive efficiency efforts and a sensible level of pricing.
When you look at just the margin drag from pricing alone, it's worth about 100 basis points. So think about that, when we're able to keep our unit margins flat through the course of the year in the face of this inflationary environment.
Now, what that means, of course, is that the overall margin progress that we've made is by leveraging our above unit costs. When you think about that, as we look into the future, once you have our top line growth rate, which it'll be there, thereabouts next year just given the comps and the like, the margin progress will be much smaller if these inflationary pressures continue at this level. So I think we've perhaps done not a sufficient job of explaining the inflationary pressures and the mitigation efforts that we've had to face into.
With respect to North America, the lower growth rate is all about the comps, first and foremost. If you go back to last year, you saw significantly increased reopenings as the year progressed. The first half of last year, as a group, we were operating at about 98% of 2019 revenues. And the second half, that stepped up to 113%. So a massive step up, H1 to H2. That was led by North America. The North America was really the first of our regions to reopen in a big way. And so, what you're seeing now is more of a normalization from North America that the other regions are catching up to. North America is still growing significantly and we expect that to continue going forward.
We'll now move to our next question from Vicki Stern from Barclays.
Just wanted to follow-up on the margin points. So [Technical Difficulty] previously when we were bridging back to the pre-COVID margin, 40 bps from inflation and another 40 bps from sort of net new ramp up. You now say 40 bps from inflation is now more like 100 bps. And I suppose just thinking about when inflation may normalize [Technical Difficulty], is that 100 bps that you think you ultimately get back? Or should we think about that as some of that [Technical Difficulty] back in time?
And then just Secondly, an update please on signings? Obviously, you've got current signings [Technical Difficulty] indication of the future pipeline. Just so keen to know what those look like. Is that still sort of as consistent with that kind of 4% to 5% net new?
First of all, just on margin, I think, look, what we said is we anticipate we'll continue to make margin progress. We've said there's no reason – we absolutely see a path back to pre-COVID margin and we see no cap on the margin as we go forward. I think what we're just trying to do today is explain the pressures that the heightened inflation for a prolonged period is placed on the business and our ability to mitigate that.
Do we think we'll get that full 100 bps back over time? No, because in reality, it's been a reset of the cost base. And of course, we've benefited from that through the top line on which we've earned a slightly lower margin, but still a good margin, I think is the way we look at it. And that's why I think you have to focus on the absolute pounds and the profit growth.
But I think what's really important is we still see a path back to pre-COVID margin. We'll get there over time. I think a lot will be about when conditions normalize and we'll update you as we always do as we go.
In terms of signings, we've signed £2.5 billion new business ARO over the last 12 months. We still expect this full financial year to be another record year of new business signings. We've got a very strong pipeline. We're anticipating a strong fourth quarter. And it's that in combination with a very strong retention rate, which is giving us that confidence around sustaining the net new business at sort of 4% to 5%. And therefore, underpinning that mid to high-single-digit growth as we go forward.
Our next question comes from Leo Carrington from Citi.
If I could ask a couple on the recent growth trends, it seems like the last six months or two quarters in Europe have seen the best sequential progression. And I get the point about the catch up effect. But just in the last few quarters, I'm curious to know the specific drivers. And connected to this, perhaps, I think there's also been a higher-than-usual sequence of contract announcements, contracts wins in the UK. So perhaps, if this does tie in, any color on the drivers behind this, and specifically for Europe?
And then, in terms of the headline KPIs, backing out for Q3 implies something like 3 percentage points of like-for-like volume growth. That seems remarkably good, given the maturity of the recovery. And, again, may tie in to previous questions, but if you could outline the drivers and the expectations going forward, that would be very helpful.
I'll take growth and then Palmer talk to volume. Yeah, as we've said at the half year and I'll repeat today, we're really pleased with the performance in Europe. The performance we talked about the half year, we've sustained through the quarter, anticipating sustaining through the full year.
Again, I think you have to just kind of strip back the components of growth in Europe. As Palmer rightly said, North America reopened first, Europe next and then the rest of world latterly. So, we're seeing that effect on the volume recovery and that lag through the regions as it were, and hence why we're seeing the North American growth sort of come off first from a volume standpoint.
But if you look at net new, we've got North America and rest of world trending just around the 5%, whilst Europe is slightly above that. And that's really the positive delta for us, to see Europe above the net new growth rates of the other regions. And that, as you rightly say, has been predicated on the best retention performance we've seen in the region. And that applies across both the UK and continental Europe, as well as very strong new business signings, as you reference.
We're excited by what we're seeing in Europe. The wins are coming across all of our core sectors in the UK and in continental Europe. The pipeline remains exciting. And we're optimistic about the level of signings we'll see in the balance of this year and our ability to sustain net new growth in Europe into the next financial year as well.
With respect to your question, Leo, on the volume growth, you're right, the math implies about a 3% or slightly over like-for-like volume in the quarter. That's 9% year-to-date. This is something we anticipated at the beginning of the year. And if you'll recall, we called that out, just the gradual regression of that like-for-like volume, all about the timing of the recovery and the comps, just as we talked about before.
Really what we saw in Q3 was just a bit of perhaps the last of the recovery volumes. As we look forward to Q4, really, at this point, we feel like from a revenue perspective, we're fully normalized. So, henceforth, any volume growth would be incremental volume growth, comparable to what you've seen from us historically and not really any noise from the recovery. So that's really the way we're looking at it going forward.
We will now move to our next question from Kean Marden from Jefferies.
Two questions please. First of all, just looking at logistics issues in the US at the moment [Technical Difficulty] just wondering if you can provide some insight, how you managed supply chain [Technical Difficulty]. And more broadly, [Technical Difficulty].
We struggled a little with your line, but I think I got them. I think the first was logistics issues in the US surrounding strikes and bankruptcies, I think you said, and then, secondly, the debtor aging profile in North America.
Kean, was that specifically the debtor aging specifically in the US or globally was the question?
Just we're seeing bankruptcies increase in the US, mainly [Technical Difficulty] towards that territory, yeah.
I'll take those. We are seeing a bit more activity on the strikes piece, the labor front, and a bit more financial pressure on some of our clients, particularly in the healthcare sector, and the like. Bankruptcies really aren't affecting us. So, we're not seeing that in any real meaningful way, really not seeing anything cross my desk on that front. So probably speaks to the level that we're really seeing there. But we do know there's a lot more activity – there's always some bit of activity. So we're just managing it as we normally do.
With respect to the debtor aging profile, I think there are a couple of things that are happening there. One, just the shape of the business is a bit different. So when you look at business mix, that's a bit more focused on what we call map one or client pay versus map two or consumer pay. It inherently uses a bit more capital. The same thing is if it's a bit more on the management fee structure versus a P&L structure, there's a bit more working capital that's involved. There's also a bit of geography mix as well where we're seeing higher growth rates out of Europe, which is much more focused on the client pay than the consumer pay. So there's a bit of that, there's a lot of aspect to it just there.
And then also, just as we touched before, there is a bit of financial pressure, others coming in, in each of the regions, although it's not material in the round.
And we'll take our next question from Neil Tyler from Redburn.
A couple more from me, please. I'd like to ask you both for slightly more perspective on the like-for-like volume growth again, return to that topic. You mentioned that there's a small contribution outside of North America from recovery. But away from that, can you share some perspective on the sort of split of what's left between changes in participation rates, perhaps sequentially? I'm thinking particularly in B&I and sports venues, leisure venues? And then what might be left from ramping up of new contracts? So that's the first question.
Secondly, retention rates, obviously, very, very healthy. Previously, you've talked about the efforts you put in during the pandemic around contract renegotiations. And I wonder if we think sort of two, three, four years out from here, whether you believe the sort of retention rate is benefiting from having locked in customers who might in previous times have already put those contracts out to tender or whether there's something else that has changed in the business that you more structurally can support retention rates at the current level for the longer term.
Look, it's really pretty difficult to pull apart the like-for-like volume growth in a quarter, given that there are so many different moving parts. As we said, we signaled that there would be a slowing in volume recovery as we lap the reopening. I think it is fair to say we're pleased with the volume growth we saw in the third quarter.
And I think you're absolutely right, within that, there are a number of elements. So, first, we are still seeing some reopening benefits in Europe, rest of the world, albeit that, really, I think we feel will come to an end in the third quarter and we'll see little of that in the fourth.
I think we continue to see some return to office benefits. And that, whilst there has been a reopening, we still see an increase in office attendance and in participation, which is positive. That is, of course, being offset by some of the redundancy programs that we've seen announced previously in tech and in financial services more recently. So there are sort of trends and countertrends within that.
And you're absolutely right. We had sort of pent up openings a year ago in B&I, in particular, and as those contracts have matured into year two, we're still seeing some volume growth on them. So I think we feel pretty good that when you sort of add up all of those puts and takes, we're in sort of strong and positive volume territory. Our guidance and expectations for quarter four is that that's broadly flat to slightly positive. If it were to be better, that's where we might see any upside.
In terms of your question on contract renegotiation, whether that's benefiting retention, I don't really look much past the same factors, as we seeing impacting new business positively impacting retention. In this very challenging world with high inflation, I do believe that we're best placed to manage those pressures for our clients, that they've seen it firsthand through the pandemic through reopening and through the cost of living crisis. And therefore, when we do come to the retention discussions, there's real evidence that benefits we can bring them that makes us a more compelling partner. So I think the reasons we are winning more is the reason we're also retaining better. And I think we've established an awful lot of goodwill over the last few years, and the manner in which we've dealt with the various issues that we've faced, and I would say not least in the manner in which we've priced.
As Palmer referenced earlier, I think we've been very transparent with our pricing. We've demonstrated the gross cost inflation. We've demonstrated the absolute pounds millions mitigation that we can deliver for our clients. And we've only sought to pass on that real net cost inflation after we can do everything. And we've sought to offset the margin dilution through our own other initiatives. So I think that combination of sort of the approach that we've led to these various issues has left us in a good place with our client base.
We think we've seen a bit more go out for retention in the last six months or so. And yet, we're sustaining these very positive levels of retention. So, we feel good about where we are, and of course, yes, those positive levels of retention will underpin our growth over the next few years.
Just a couple more thoughts on the retention piece. As Dom mentioned before, the macro status helps on the retention side, just as he touched on earlier. But also, as he touched on earlier with respect to Europe, we've done a lot to improve our processes and our focus within Europe. That's the region where we've seen the biggest step up in terms of retention rates. And it's been a massive priority for us. And it's great to see that come through.
This is a record rate. We've kept it for several quarters now. We look at it, on one hand, as a record. On the other hand, if you look at it in the inverse, that means we're still losing upwards of £700 million or so of business. And we think we can do better. So, we take a very much of a micro focus on how we try to drive retention and that's paying off.
[Operator Instructions]. We will now move to our next question from Harry Martin from Bernstein.
A couple of questions for me. The first one is on sports and leisure within North America. Some of the commentary we've seen on attendances and per capital spending is still suggestive that the sport and leisure season is running very well. So I wondered if you could comment on where that stands potentially next to the 14% organic growth for the entire North America businesses. Is sports and leisure running ahead?
The second question is on new wins. Now that the key selling season in education is, I understand, mostly over, where are we tracking relative to the £2.5 billion, the annualized wins you did last year? And do you expect that to be flat or slightly up compared to last year or a little bit down?
On your first one here in North America sports and leisure, you've heard from us previously that the consumer spending has been very strong, surprisingly strong in that segment, and that is continuing, and we're not seeing any signs of weakness thus far. So that trend is staying consistent.
Similar to the theme from some prior conversations, you saw a massive reopening of sports and leisure really in the second half of last year. So you're starting to lap that a bit, the consumer spending within that, even though today continues to be strong.
On the new wins side of things, just as Dominic referenced before, over the last year, we're at £2.5 billion. We've got a very strong pipeline. We're excited about the pipeline. We think this year can be a record setting year for us. As you know, it's lumpy and the timing is unpredictable and uncertain. But we're always focusing on expanding that pipeline and raising our conversion rates. So it's something we feel good about.
We will now move to our next question from Jaafar Mestari from BNP Paribas.
I have two, if that's all right. Firstly, on the environment you described today, just curious whether it means anything for the balance sheet? Is this an environment where you'd be fully comfortable with 1.5 times net debt to EBITDA? Or would your preference be to be slightly below you're likely to be post buyback at the end of the year until some of the remaining uncertainties have completely abated?
Just secondly wanted to come back on one prior question. So when margins were 6.5%, that was 100 bps below pre-COVID levels, and you were describing precisely where that came from. And I think you were saying 40 bps drag from inflation, 40 bps drag from startup costs from new business and then 20 bps drag from OpEx into the general capabilities, digital investments, etc. Is that a bridge that you have a basis now that you're close to 7%? Or at 7% for H2? And startup costs, in particular, and digital OpEx, are they being phased out as you expected, or at least are they being better amortized with the higher revenue now?
With respect to the balance sheet, we've got a capital allocation framework that we apply. We start by looking at organic opportunities. That comes in the form of CapEx.
One thing to really call out there, we said at the half year, we expect the CapEx for the full year to be in the 3% to 3.5% range. We now expect that to be at the low end, so closer to 3% for the full year. Not exactly sure, again, that that's a permanent trend. It's something we're keeping an eye on, but certainly for this year, that's where we expect it to be. So first and foremost, we take advantage of organic growth opportunities, then we look at inorganic, mainly in the form of M&A. You'll see we've done about £272 million or so of spend year-to-date.
Very little in Q3. We are looking at a number of opportunities currently in all of our regions. Some of that may happen in Q4 or may extend it to next year. We will keep an eye on the level of activity and the quantum there.
And then, any excess above the target leverage, we will return to shareholders. We do expect that target leverage to be in the midpoint of our range by the end of the year when we complete our current £750 million buyback.
Look at the landscape, including the M&A landscape, and we'll make some decisions there. So I think we'll look at it in the same way that we've been looking at it the prior two quarters. We are very cognizant of the interest rate environment and the raising of additional debt and what that does. So, there's a constant balancing just there.
On the margins front, Vicki touched on this a little bit earlier as well. At this point, it's more weighted towards the inflationary pressures. You are seeing a normalization of the mobilizations. So as that continues to move forward, that particular drag declines, but inflation has been stubbornly high for a while now. I think we've shown we can manage it fairly well through our mitigation efforts and partnering with our clients is a big piece of it as well. It's really hard to unpick that precisely, but it would be more weighted towards the inflationary aspect now.
And then, just that extra bit on the digital OpEx and general investment in your global capabilities there, is that something that [indiscernible] or is the 20 bps [Technical Difficulty] for the long term?
I think what's really important is we need to continue to invest in our business, we need to invest in sales retention operations, we need to have the best talent in the industry, we need to have digital and data led solutions for our clients. And we're not going to hold back on those investments, absolutely the right thing to do.
I think as you rightly said, we're touching 7% in the second half. We've made significant progress this year on margin. I think it's 50 bps on a full year basis despite the very significant inflationary pressures. And we will continue to make margin progress from here. And that will be in addition to higher growth. I think we just need to balance the need to invest in this business to sustain mid to high-single-digit growth over multiple years and to maximize the opportunity that we think of a very, very exciting market. This market today has got more growth opportunity than I've ever seen.
Thank you. And as there are no further questions in the queue, I'd like to hand the call back over to Dominic Blakemore for any additional or closing remarks. Over to you, sir.
Yeah. Simply just say thank you very much for joining us. We wish you a very restful and enjoyable summer and we look forward to speaking with you again in November. Thank you.
Thank you. This concludes today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.