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Should I Buy Compass Group plc?

I’m out shopping for shares again. Should I add Compass Group (LSE: CPG) to my wishlist?

Finding my Compass

Contract caterer Compass Group got my juices flowing last time I examined it in February. The group, which serves four million meals a year in 50,000 locations, was shrewdly moving into other outsourcing areas, including reception and office services, cleaning and maintenance. The market had priced in health future growth, however, because it traded at 18 times earnings. Does it look better value today?

Compass Group’s share price has risen 30% in the past 12 months, against 13% for the FTSE 100 as a whole. Over five years, it is up a meaty 212%, against 65% for the index. Last month, management reported “good performance” in Q4 and predicted organic revenue growth at just over 4% for the full year, or 4.5% including recent acquisitions. Its full-year operating profit margin is on course to top 7% for the first time, and free cash flow conversion remains strong. Very satisfying.

Food, glorious food

Compass has been winning new business and retaining existing clients, but it isn’t growing everywhere. Organic revenue growth of 7.5% in North America — and 10% in emerging markets such as Brazil, India, Turkey and China — masked a 3% decline in Europe and Japan. Worryingly, there has also been a modest slowdown in emerging markets growth rates. This is due to “challenging economic conditions”, rather than any flaw in its service delivery, but Compass clearly needs the global economy to keep growing. Any major setbacks, and its revenues could head south.

Management has been cutting costs, to offset European slippage. Its globally-diversified portfolio of clients covers both defensive and cyclical industries, which should also give it some ballast. Loyal investors are being rewarded with a £400 million share buyback programme, to be concluded this year, and management recently hiked the half-year dividend 11% to 8p. Sadly, that leaves it yielding just 2.4%, against the FTSE 100 average of 3.5%. I would have expected better.

Losing my bearings

Earnings per share (EPS) growth looks positive, at 10% to September 2013, and 8% in the 12 months after that, but Compass is even more expensive now, trading at 20.8 times earnings. Deutsche Bank names it a ‘buy’ with a target price of £9.67, some 8% above today’s share price of £8.93. Compass could serve up another slice of growth, but it’s too expensive for me.

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> Harvey doesn't own shares in any company mentioned in this article