I started buying shares in FTSE 100 contract catering firm Compass (LSE:CPG) in April. And my top priority is adding to my investment in May.
It’s a name a lot of investors aren’t familiar with. But I think a closer look reveals a lot to like – especially at today’s prices.
Competitive advantage
Compass provides meals for venues including offices, stadiums, and hospitals. It’s the industry leader and bigger than its nearest two competitors combined.
That scale is a huge advantage. It means the firm has lower costs than competitors which allows it to offer customers lower prices. Ultimately, this is key. One of the big reasons organisations outsource their catering is to keep costs down, so value matters a lot.
As if this wasn’t enough, Compass also monetises its cost advantage directly. It allows other operators to buy through its platform – for a fee. That reinforces its key strength while generating high-margin revenues. And it makes the business incredibly difficult to compete with.
Why now?
All of that sounds good, but it doesn’t explain why I’m interested in the stock right now. The reason is that I think the valuation is unusually attractive.
Compass is one of the few FTSE 100 shares quoted in dollars. That’s because most of its business is based in the US. The firm’s enterprise value is $49.85bn and it made $1.975bn in free cash last year. But I’m looking for a 10% annual return over the long term.
Based on a reverse discounted cash flow (DCF) calculation, this implies 10.7% annual growth for the next 15 years. Is that achievable? I think so. It would be a tall order for the majority of businesses, but Compass has some unusually strong growth prospects.
Growth opportunities
Compass is the industry leader by some margin. But its market share is only around 12%. That means it has a lot of scope for future growth. And it has two main ways of expanding into the available space.
One is by growing its existing businesses. In its latest update, Compass reported 7.3% organic revenue growth. By itself, that’s set to generate 10% operating profit growth – close to the 10.7% target. But the firm also grows through acquisitions.
A fragmented industry means there’s a lot of scope for this. And that’s a big reason why I think the current valuation’s attractive.
What could go wrong?
I don’t think competition is a big issue for Compass Group. The bigger risk, in my view, is demand.
In any kind of recession, venues might naturally look to cut costs. And one way to do this is to outsource things like catering. That’s good for Compass in the short term. But if it translates into venues going out of business, that becomes a problem.
As an example, US hospitals have been under pressure recently. And I’m monitoring that situation, for a few reasons. Compass has very strong retention rates, but that won’t help if customers go out of business.
I’m a buyer
I think Compass Group offers a great combination of growth prospects and competitive strength. And the valuation looks attractive to me right now. That’s why I’m looking to make it a bigger part of my portfolio in May. I like a few FTSE 100 names, but this one stands out.
