January 24, 2021

Compass: Starting To Right Itself (OTCMKTS:CMPGF)

U.K.-based catering and outsourcing group Compass (CMPGF, CMPGY) brought the market up to date with a trading statement before its year closes. Its business is still in very choppy waters but the company is working hard on breaking even. Management have impressed with their performance in the fourth quarter. I remain neutral on the name awaiting further evidence of a sustained recovery, but the latest snapshot does suggest that it is moving in the right direction.

Business is Still Down But the Trend is Improving

Revenue is projected to be 19% on the year before. However, Q3 was clearly worse hit than Q4. In each region, Q4 showed a mark improvement, especially in Europe. It had taken the largest hit in Q3, with business down to 47% of normal levels, but in Q4 it had recovered to 61% of normal levels.

Source: company trading statement

Despite the improving trendline, revenue was still far below what it would normally be. Even in the best performing region, the rest of the world, revenue in Q4 was just 82% of what it had been the prior year. While that does not sound like a catastrophic loss, it would clearly be problematic for the economics of the business if it were to be sustained at that sort of level. Meanwhile, the key European and North American markets continue to run at a little over 60% of usual revenue, which is a sharp contraction.

The company didn’t break Q4 down, so it is hard to ascertain whether the revenue rate at the end of quarter showed improvement over the rate going in. However, it did say that clients are starting to return to schools and offices in its main markets, which suggests that revenues will continue to recover. However, the rate of recovery remains unclear. Based on the latest figures, it seems reasonable to expect that the next couple of quarters will not see full revenue recovery, so 2021 while it may beat 2020 will still fall short of 2019.

There are Some Bright Spots in Performance and Liquidity is Strong

It is also worth noting that the dip in revenues varied not just by region but also sector. For example, while the sports and leisure operations in North America remained closed, healthcare was described as performing well. The picture was broadly similar in Europe, while in Asia, education came back earlier than it has in other regions.

While on their own those aren’t enough to support the company’s health, it is worth pointing them out – Compass isn’t wholly reliant on a single sector, so if for example, homeworking continues for many office workers but education restarts on campus (as has been the case in the U.K., for example), the company’s diversification will help. Better performing divisions will help mitigate the almost total non-performance of divisions such as sports and leisure.

It is also important to note that the company maintains strong liquidity. It forecasts around £5 billion of liquidity at the end of September, including £1.6 billion in cash. That helps it ride out difficult times but it also means that it has space to invest in building the business for the post-pandemic era, as shown for example by capex spending in the quarter which included money to support new business wins in North America. Longer term, this liquidity helps the company maintain its competitive advantage despite having spent much of the past couple of quarters firefighting like its peers.

The Company is Looking to Breakeven in Q4

While the revenue news was mixed, something which is largely outside the company’s control as it is largely driven by external factors such as lockdown policies, the news on the profit side was better.

The revenue increased have helped to stem losses in the company’s fourth quarter. But there have been other drivers in improving the bottom line versus the preceding quarter. These include contract negotiation and what the company described as “a relentless focus on efficiencies”. That rather grim sounding phrase seems like a euphemism for heavy cost cutting. Longer term that may impact on staff morale or service quality, but in the short term it helps stop the company bleeding money.

With all of that, the company guided that it expects the operating margin in the fourth quarter to reach the breakeven point. That is before taking account of impairments associated with renegotiating contracts, the rationale for that exclusion being that such impairments are one-offs to reset the business. Even including those impairments, which the company estimated at around £100 million, operating margin in the fourth quarter was still estimated to be -3%, which while negative is not catastrophic. Over the full year, the underlying operating margin is forecast to come in at around 3%.

The company also incurred resizing costs in the fourth quarter of around £90 million. As with contract impairment, I think it is understandable for the company to incur costs to get its business in the right shape and size for the new environment it faces.

The management deserves credit for having worked hard to stem losses so that, even on a sharply lower revenue base, the company is able to breakeven at the operating level. Compass is a supertanker of an organisation, with just under 600,000 employees reported last year, so righting the course of the bottom line so rapidly in a pandemic environment which initially decimated demand in key markets is indicative of its high quality, decisive leadership. Decisiveness was in evidence earlier this year with the company’s massive capital raise, and it remains on show now – in a crisis particularly, that can be critical for survival. Medium-term, it bodes well for the investment case.

Conclusion: More to Prove, But a Promising Start

I said in a previous piece on Compass (Compass Group Plc: A Tough Road To Recovery) that the company was best avoided until there is solid evidence of recovery. There is not yet such evidence: revenues remain far below where they were pre-crisis.

However, the latest news from the company is positive. Not only is it financially encouraging, it also demonstrates that the company leadership is doing what it is paid to do, in terms of steadying the ship and fast, despite a lot of things being outside its control. That bolsters the attractiveness of the name.

The market reacted poorly, marking the shares down over four per cent in London trading after the figures were released. That is an overreaction in my view, as the news was positive and bolsters rather than diminishes confidence in the long-term investment case. Although the company has a challenging road to recovery, it is performing well to date, which inspires confidence.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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