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The dust-covered Compass message board
Yet Compass has been a star performer since it came to the market in 1998 after being formed in a management buy-out from Grand Metropolitan the year before. In the last ten years its share price has risen from 70p to over £8, an annual compound increase of 28%. Since 1992 it has transformed itself from a business with 99% of its total turnover of £345m being derived in the UK to a multinational business with sales of £4.8b. So why the anonymity?
Contract catering is not exactly the most glamorous of businesses. But it is a very large one. Compass reckons the global foodservice market is worth about £200b, which means they have a market share of just 2.5%. Their medium-term target is to double this. This is yet another business where there is continuing trend towards outsourcing by big companies to specialist operations. Compass thinks that even in the UK less than 30% of the market is outsourced and that the trend has further to run.
That appears to make sense but there may be an opposite force at work as well. As more and more people choose to work from home the size of the market could conceivably shrink. There also seems to a trend away from companies offering canteen services to their staff. But then again you can't have everything. Serving office workers is just one part of the group's business. Catering for events and venues is also a big growth area.
Compass seems to keep winning the big contracts. In the last eighteen months or so their big wins have included a 4-year deal with Ford to feed 12,700 workers in the UK and 7-year deal with the Ministry of Defence worth £500m. They have also won the contract for the 2002 Winter Olympics, a 10-year contract with United Technologies worth $300m and a 5-year deal to feed 25,000 Microsoft employees. On top of all these new wins the underlying business is said to growing organically at a rate of 8% per annum. That was the rate of growth in 1999 and management thinks this can be repeated in 2000. Impressive stuff.
North America is now the group's biggest market, accounting for 33% of turnover. The UK is the next biggest at 17%, followed by France with 14% and Germany with 7%. Whilst the UK side of the business is the most mature it is also the most profitable. Profit margins come in at 7.5%. That isn't desperately high compared to most businesses but it is significantly greater than the 4.9% generated from operations outside the UK. Is this another case of UK customers paying more? Or perhaps the margins from the rest of the world will continue to play catch-up with the UK? That's a difficult call. An increase in profit margins of 2% or more across 80% of the group's turnover would have a significant effect on the bottom line. Another possibility is that Compass could be pricing its services at a low level outside the UK in order to establish a foothold.
As well as having low margins, Compass does not score very highly in return on capital employed measures. In fact it does pretty dreadfully coming in at a measly 8.5%. That is incredibly low. That's not much better than you can get from a high-interest deposit account these days. It is above Compass's actual cost of capital but it still looks to be the weakest link in the business.
Yesterday the group published its full-year results for the period to 30 September. Compass is now trading on a multiple of 39 times earnings for that period. With the best will in the world that is a pretty generous valuation. Some upgrades in estimates are likely as these results came in ahead of expectations. Even so Compass is still only likely to be growing by some 15% per annum. It seems some investors are prepared to pay a hefty premium for growth in these days of low inflation.
To my mind, despite the company's good track record, the risk in the price is firmly on the downside. Where the company to grow by 15% over the next two years, and the share price didn't move, it would still be valued at around 30 times earnings. Call me old-fashioned but that doesn't stand out as a particular bargain. In fact the Compass situation reminds me of another services blue chip, Rentokil Initial (LSE: RTO). And we all know what happened when their growth prospects tailed off.
Related links
Compass Group website