They say stocks go up the stairs and down the escalator. That’s certainly been the case for Compass Group plc (LSE:CPG, Financial). The stock is trading roughly where it was three years ago but hasn’t recovered its pre-Covid crash highs reached in September 2019. The company, which is one of the largest employers in the UK, operates in the vending and catering services sector.
Compass will release its full year results on Nov. 23. It produced an optimistic pre-close trading update on Sept. 21. Sales have come back faster than expected after the lockdowns battered demand. That’s because people have begun returning to offices, students are back on campus and big sporting events have resumed.
Compass’ valuation isn’t particularly cheap. Indeed, the GF Value indicator puts it at modestly overvalued. A forward price-earnings ratio of 24.6 indicates that the market is also fairly optimistic on this stock, given it's in the consumer discretionary industry, which typically has lower valuations. However, compared to its own history, Compass does appear slightly undervalued: its Shiller price-earnings ratio is 27.5 vs. its 10-year median of 33.1, and its price-book ratio is 5.6 vs. the 10-year medium of 9.
While Covid-19 isn’t going away any time soon, the world is beginning to become less cautious of it, and in a year or two, things will probably be fairly back to normal.
Compass’ revenue, which during its fiscal fourth quartercame in at about 86% of the 2019 level, was ahead of guidance. The return of baseball in the U.S. and Premiership football in the UK were the main drivers for gains made by its sports and leisure business. With the public’s savings accumulating over lockdown, consumers spent more than usual too.
Market consensus is for a return to pre-pandemic revenues and pre-tax profits in 2023. However, I believe we could see a quicker return as Compass has managed itself well during the pandemic.
Capital raise
The company deserves credit for its performance over the course of the pandemic. It has repaid furlough support payments and in May last year, the company secured a 2 billion pound ($2.75 billion) share placing, which helped shore up the balance sheet and prepare for the tough times ahead.
The issue the company now faces is how many businesses will return to five days a week office work. Compass’ core business and industry division, which supplies offices and factories, accounted for 38% of group revenue during the first half of 2019, well above healthcare and seniors at 23%. By H1 this year, that had fallen to 32% of group revenue and had only reached 60% of the pre-lockdown level.
For the H1 period, its Education segment was at 69% of 2019 levels, but Health and senior living and Defence, offshore and remote had seen growth of 5% and 8%, respectively.
Management guided investors not to be too optimistic on the Business and Industry segment rebounding much further in the near future, so we’ll need to see if Compass is able to achieve revenues in line, or above, pre-pandemic levels based on further growth in its Health and senior living and Education segments to offset lagging corporate revenue. However, from my own observations and expectations, I believe office life will return to normal sooner rather than later. I don’t buy into the narrative of the shift to a more permanent work from home working structure - bosses are too fond of micromanaging their employees, and many jobs really can be done more efficiently in an office.
The scale of Compass means that it has managed to survive the pandemic, and it can pick up business where other rivals have disappeared. Its size can give it economies of scale to help it fight the inflationary costs we are seeing, which should enable it to remain competitive vs. smaller rivals when tendering for new business.
Currently, the performance of margins shows Compass is managing inflationary pressures well, as it increased the underlying margin guidance to a mid-point of 5.5% to 6% during Q4. The company has a target to return the margin to 7% before sales recover to the pre-crisis level. Of course, with inflation rising steeply, there’s a risk that progress here could take some time. For investors interested in the stock, it’s worth reading the risk factors section of a recent prospectus for a Euro Medium Term Note program.
Conclusion
Overall, I like Compass because I think it has better than expected growth coming as the world gets to a new normal; I believe that in one or two years, things will look closer to 2019, moreso than many people expect. Compass is also protecting its balance sheet and has a pretty good Altman Z-Score of nearly 3.
I don’t expect too much income from the stock, with a dividend yield of less than 1% as management looks to defend the balance sheet, but I expect revenue and profitability to grow, and valuation multiples to expand, giving the stock decent capital appreciation over the next two or three years.
