Questor share tip: Compass too rich right now

Compass Group
984p+23p
Questor says HOLD

COMPASS [LON:CPG] is one of the largest catering groups in the world and the steady revenues that come from serving up meals means that the shares should be on the menu for investors. The company said yesterday that it had finished the financial year with strong trading in North America and that should enable it to return more cash to shareholders.

An army marches on it stomach, according to Napoleon Bonaparte, but fortunately for Compass many businesses, hospitals, care homes and sporting events need feeding as well.

The FTSE 100 group has grown into a global giant by using its size to drive down the cost of ingredients while pushing through price rises in line with inflation. Food makes up 80pc of its business and it caters for 50,000 different locations round the world.

Because people still need to eat even in a recession, the revenue is pretty reliable and the company is also well diversified geographically. Today, about 45pc of its revenues come from North America, 35pc from Europe and Japan and the rest from newer markets such as Australia.

Compass said North America served up the best performance in the year to the end of September. Retention of existing catering contracts was described as “excellent” and new business wins accelerated in the second half of the year. Overall that meant organic revenue, which doesn’t include acquisitions, increased by 6.5pc – ahead of the 4pc revenue growth reported across the whole group. New business isn’t being won by cutting prices. The company said it expects the profit margin to inch ahead for the full year.

The only problem with having so much business in the US has been the strength of the pound. When taken across the whole year, the strength of sterling against the most important currencies, such as the US, Canadian and Australian dollars, the euro and the yen is estimated to have reduced revenue by £1.18bn and knocked £89m from underlying operating profits.

Revenue in the struggling economies of Europe and Japan fell by 1.5pc but that decline is half the rate of a year earlier and there are signs of improvement with the profit margin edging up in these regions too. The fast-growing and emerging markets delivered organic revenue growth of 8pc last year.

The company said it had managed to improve profit margins across the whole group by 10 basis points up from 7.3pc to 7.4pc, as the group kept taking out costs and finding ways to operate more efficiently.

Compass also expends a lot of effort managing its menus so it is not exposed to swings in food commodity costs.

The one area that Compass has no control over is food regulation, which could result in costs rising. Only last month the Government said hospital canteens will have to meet lower levels of salt, sugar and saturated fat. Over the long term these changes should be manageable but changing menus and ingredients could increase costs over the short term.

That said, Compass is still a steady, and more importantly, cash-generative operator. The company paid out a £1bn, or 56p per share, special dividend on July 7 and has pledged to buy back £500m worth of shares over the next year. As at the end of September the company has spent £174.5m on its own shares and plans to hit the £500m mark during 2015.

Questor looked at the shares last year, tipping them as a hold when they were at 878p. The shares are trading on 20 times earnings, falling to 18 times next year and have come back from record highs of £10.50 in early July.

Questor thinks Compass is an excellent defensive share but not for buying at these prices, so we retain the hold.