Compass Group PLC (CPG) Earnings Call Transcript & Summary
July 25, 2023
Earnings Call Speaker Segments
Operator
operatorGood day, and welcome to today's Compass Group Third Quarter Trading Update Conference Call. This meeting is being recorded. At this time, I would like to [Audio Gap]
Dominic Blakemore
executiveGood morning, everyone, and thank you for joining us. As usual, I'm here with Palmer, our CFO. We've had another good quarter with strong organic revenue growth of 15% and 21% year-to-date. This reflects net new business growth nicely balanced across all of our regions, the right levels of pricing and strong like-for-like volumes. And of course, this is despite lapping the full reopening of assets since last year. Our client retention rate remains excellent at 96.7% and we have an exciting pipeline of new business opportunities across all of our regions. Despite persistent inflationary pressures, we're encouraged with our margin progress. Food inflation appears to have peaked and is easing in some regions, but we expect our basket of cost inflation to be above CPI and historic levels for some time to come. We're well placed to manage this with mitigation and sensible pricing whilst increasing our competitiveness relatively to the high street. And of course, these cost pressures accelerate outsourcing. We're very pleased with the continued strong momentum and performance of the group, and we reiterate our full year guidance. Longer term, we expect these growth opportunities to sustain mid- to high single-digit organic growth and incremental margin progression, leading to profit growth above revenue growth. Our proven value creation model will continue to reward shareholders with compounding returns. Let's now move to Q&A.
Operator
operator[Operator Instructions] Now the first question comes from Jarrod Castle from UBS.
Jarrod Castle
analystGreat. I'll ask the normal 3. You said that cost pressures are helping outsourcing. But I'd also like to just get some color if you're still seeing customers being attracted more to the larger players in contract catering in terms of consolidating around the larger players rather than the regional smaller players. And then 2 questions just around margin. Obviously, the Americas, very tough, base effect is delivering low organic growth to other geographies. That's going to obviously have a mix impact on your margin, given it is your highest margin business. How do you see the ability to offset that, given raises in both Rest of World, maybe in North America and, obviously, Europe? And then just linked to your -- I guess, your goal of getting back to previous margin levels, any view on kind of time frames? Or is this just going to be dependent on kind of the organic growth you deliver?
Dominic Blakemore
executiveYes. Thank you, Jarrod. Let me have a go at [indiscernible] let Palmer then add some color to each and take the second question. First of all, in terms of your question around cost pressures and whom it most impacts, if you take a step back, we believe that at a time like this with significant inflationary pressures and the complexities of operating in this environment that we've signaled for a while, the benefits of scale are very significant. Now that applies, first and foremost, to [ self-op ] where those pressures are most keenly felt. But equally applies to smaller players that don't have the benefit of buying power, our ability to manage menus at scale and so forth. And so yes, we do believe that it's creating opportunity for us against, really, both in the first-time outsourcing opportunity and with the small players. And we think that -- that is set to continue with the sort of inflationary levels that we anticipate for a while yet, as you heard me say. In terms of the margin levels, I think what's really important is we now need to focus as much on profit growth as we have on margins. We're growing profit significantly above the levels that we did pre-COVID. We believe that our revenue growth is going to accelerate into the range we've discussed on a sustainable long-term basis and that our profit growth will be above that with incremental margin progression. So we've always said there's nothing to hold us back from getting back to the pre-COVID margin. We're very focused on that accelerated profit growth and really seeing margin as the outcome of that. I think it's also fair to say, and I'm sure Palmer will touch on it, with the level of cost inflation that we've absorbed and by doing the right thing vis-a-vis our clients, which is to price for the net cost inflation without pricing for margin on that. That represents a margin drag that we've had to offset. So really, there's been a bit of a reset within our margin structure. And therefore, we're super focused on the profit growth is the right KPI for the business going forward.
Palmer Brown
executiveJust some color on the last point before I get to your question on North America, Jarrod. On the cost inflation, in the past year, we faced over GBP 1.5 billion of inflationary pressures on our cost base. It's over GBP 3 billion over the last 2 years. This year, we have been able to keep our unit margin flat facing those inflationary pressures. That comes from massive mitigation efforts, massive efficiency efforts and a sensible level of pricing. When you look at just the margin drag from pricing alone, it's worth about 100 basis points. To think about that when we're able to keep our unit margins flat through the course of the year in the face of this inflationary environment, now what that means, of course, is that the overall margin progress that we've made is by leveraging our above unit costs. When you think about that, as we look into the future, once you have our top line growth rate, which it will be there thereabouts next year, just given the comps and the like, the margin progress will be much smaller if these inflationary pressures continue at this level. So I think we've perhaps done not a sufficient job of explaining the inflationary pressures and the mitigation efforts that we've had to face into. With respect to North America, the lower growth rate is all about the comps, first and foremost. If you go back to last year, you saw significantly increased reopenings as the year progressed. The first half of last year, as a group, we were operating at about 98% of 2019 revenues. In the second half, that stepped up to 113%. So a massive step-up H1 to H2. That was led by North America. North America was really the first of our regions to reopen in a big way. And so what you're seeing now is more of a normalization from North America that the other regions are catching up to. North America is still growing significantly, and we expect that to continue going forward.
Operator
operatorWe'll now move to our next question from Vicki Stern from Barclays.
Vicki Lee
analystJust wanted to follow up on the margin point. So [Technical Difficulty] inflation and another 40 bps from sort of net new ramp-up. You now say 40 bps of inflation is now more like 100. And I suppose just thinking about when inflation may normalize [Technical Difficulty] Is that 100 bps that you think you ultimately get back? Or should we think about that as some of that [Technical Difficulty] get back in time? And then just secondly, an update please on signings. Obviously, you've got current signings [Technical Difficulty] indication of the future pipeline. Just sort of keen to know what those look like and if that's still sort of as consistent with that kind of 4% to 5% menu?
Dominic Blakemore
executiveYes. Thank you, Vicki. First of all, just on margin. I think what we said is we anticipate we'll continue to make margin progress. We've said there's no reason we absolutely see a path back to pre-COVID margin and we see no cap on the margin as we go forward. I think what we're just trying to do today is explain the pressures that the heightened inflation for a prolonged period has placed on the business and our ability to mitigate that. Do we think we'll get that 400 bps back over time? No, because in reality, it's been a reset of the cost base. And of course, we've benefited from that through the top line on which we've earned a slightly lower margin but still a good margin. I think it is the way we look at it, and that's why we have to focus on the absolute [ PAMs ] and the profit growth. But I think what's really important is we still see a path back to pre-COVID margin. We'll get there over time. I think a lot will be about when conditions normalize, and we'll update you, as we always do, as we go. In terms of signings, we signed GBP 2.5 billion new business IRO over the last 12 months. We still expect this full financial year to be another record year of new business signings. We've got a very strong pipeline. We're anticipating a strong fourth quarter. And it's that in combination with a very strong retention rate, which is giving us our confidence around sustaining the net new business at sort of 4% to 5%, and therefore, underpinning that mid- to high single-digit growth as we go forward.
Operator
operatorOur next question comes from Leo Carrington from Citi.
Leo Carrington
analystFirst, if I could ask a couple on the regional growth trends. It seems like the last 6 months or the last 2 quarters in Europe have seen the best sequential progression. And I get the point about the catch-up effect. But just in the last few quarters, I'm curious to know the specific drivers. And connected to this, perhaps, I think there's also been a higher than usual sequence of contract announcements in contract wins in the U.K. So perhaps if this does tie in, any color on the drivers behind this, specifically, for Europe? And then in terms of the headline KPI, is backing out for Q3 implies something like 3 percentage points of like-for-like volume growth? That seems remarkably good, given the maturity of the recovery. And again, may tie into previous questions, but if you could outline the drivers and the expectations going forward, that would be very helpful.
Dominic Blakemore
executiveGreat. Thank you for those questions. I'll take growth and let Palmer talk to volume. Yes, we -- as we've said at the half year, and I'll repeat today, we're really pleased with the performance in Europe. The performance we talked to at the half year, we've sustained through the quarter anticipating sustaining through the full year. Again, I think you have to just kind of strip back the components of growth in Europe. As Palmer rightly said, North America reopened first, Europe next and then the Rest of World laterally. So we're seeing that effect on the volume recovery in that lag through the regions as it were. And hence, why we're seeing the North American growth sort of come off first from a volume standpoint. But if you look at net new, we've got North America and Rest of World trending just around the 5%, whilst Europe is slightly above that. And that's really the positive delta for us, to see Europe above the net new growth rates of the other regions. And that, as you rightly say, has been predicated on the best retention performance we've seen in the region, and that applies across both the U.K. and Continental Europe as well as very strong new business signings as you referenced. We're excited by what we're seeing in Europe. The wins are coming across all of our core sectors in the U.K. and in Continental Europe. The pipeline remains exciting, and we're optimistic about the level of signings we'll see in the balance of this year and our ability to sustain net new growth in Europe into the next financial year as well.
Palmer Brown
executiveAnd with respect to your question, Leo, on the volume growth, you're right, the math implies about 3% or slightly over like-for-like volume in the quarter, that's 9% year-to-date. This is something we anticipated at the beginning of the year. And if you'll recall, we called that out, just a gradual regression of that like-for-like volume, all about the timing of the recovery in the comps, just as we talked about before. Really that -- what we saw in Q3 was just a bit of the -- perhaps the last of the recovery volumes. As we look forward to Q4, really, at this point, we feel like from a revenue perspective, we're fully normalized. So hence forth, any volume growth would be incremental volume growth comparable to what you've seen from us historically and not really any noise from the recovery. So that's really the way we're looking at it going forward.
Operator
operatorWe will now move to our next question from Kean Marden from Jefferies.
Kean Marden
analyst[Technical Difficulty] help with 2 questions, please. First of all, just looking at the logistics issues in the U.S. at the moment with [Technical Difficulty] I was wondering if you can provide some insight into how [Technical Difficulty] over the last few months. Just present your thoughts [Technical Difficulty].
Dominic Blakemore
executiveOkay. Kean, thank you for that. We struggled a little with your line but I think I got them. I think the first was logistics issues in the U.S. surrounding strikes and bankruptcies, I think you said. And then secondly, the debtor aging profile in North America. Was that specifically -- Kean, is that specifically -- the debtor aging specifically in the U.S. or globally was the question?
Kean Marden
analystJust we've seen bankruptcies increase in the U.S., so [Technical Difficulty].
Palmer Brown
executiveYes. I'll take those. We are seeing a bit more activity on the strikes piece, the labor front, and a bit more financial pressure on some of our clients, particularly in the health care sector and the like. Bankruptcies really aren't affecting us. We're not seeing that in any real meaningful way. Really not seeing anything across my desk on that front. So it probably speaks to the level that we're [Technical Difficulty] there. But we do know there's a lot more activity -- there's always some bit of activity, so we're just managing it as we normally do. With respect to the debtor aging profile, I think there are a couple of things that are happening there. One, just the shape of the business is a bit different. So when you look at business mix, that's a bit more focused on what we call [ MAP 1 ] or client pay versus [ MAP 2 ] or consumer pay. It inherently uses a bit more capital. The same thing is, if it's a bit more on the management fee structure versus a P&L structure, there's a bit more working capital this involved. There's also a bit of geography mix as well where we're seeing higher growth rates out of Europe, which is much more focused on the client pay than the consumer pay. So there's a bit of that. There's a lot of mixed aspect to this there. And then also, just as we touched before, there is a bit of financial pressure that's coming in, in each of the regions, although it's not material in the [indiscernible].
Operator
operatorAnd we'll take our next question from Neil Tyler from Redburn.
Neil Tyler
analystA couple more from me, please. I'd like to ask you both for a slightly more perspective on the like-for-like volume growth, again, returning to that topic. You mentioned that there is a small contribution outside of North America from recovery. But away from that, can you share some perspective on the sort of split of what's left between changes in participation rates, perhaps sequentially, I'm thinking particularly in B&I and sports venues, leisure venues, and then what might be left from ramping up of new contracts? So that's the first question. And then secondly, retention rate is obviously very, very healthy. Previously, you've talked about the efforts you put in during the pandemic around contract renegotiations. And I wonder if we think sort of 2, 3, 4 years out from here, whether you believe the sort of retention rate is benefiting from having locked in customers who might -- in previous times have already put those contracts out to tender and whether -- or whether there's something else -- there's change in the business that you more structurally can support retention rates at the current level for the longer term.
Dominic Blakemore
executiveThanks, Neil. Yes, look, it's really pretty difficult to pull apart the like-for-like volume growth in a quarter given that there are so many different moving parts. As we said, we signaled that there would be a slowing in volume recovery as we lap the reopening. I think it is fair to say we're pleased with the volume growth we saw in the third quarter. And I think you're absolutely right, within that, there are a number of elements. So first, we are still seeing some reopening benefits in Europe and Rest of World, albeit that really, I think, we feel will come to an end in the third quarter, and we'll see a little of that in the fourth. I think we continue to see some return to office benefit. And that -- so whilst there has been a reopening, we still see an increase in office attendance and in participation, which is positive. That is, of course, being offset by some of the redundancy programs that we've seen announced previously in tech and in financial services more recently. So there are sort of trends and counter trends within that. And you're absolutely right. We had sort of pent-up openings a year ago in B&I in particular. And as those contracts have matured into year 2, we're still seeing some volume growth on them. So I think we feel pretty good that when you sort of add up all of those puts and takes, we're into strong positive volume territory. Our guidance and expectations for quarter 4 is that -- that's broadly flat to slightly positive if it were to be better, that's where we might see any upside. And then in terms of your question on contract renegotiation, whether that's benefiting retention. I think there's -- I mean, I don't really look much past the same factors as we're seeing impacting new business, positively impacting retention. In this very challenging world with high inflation, I do believe that we're best placed to manage those pressures for our clients. They've seen it firsthand through the pandemic, through reopening and through the cost of living crisis. And therefore, when we do come to the retention discussions, there's real evidence of the benefits we can bring them that makes us a more compelling partner. So I think the reasons we are winning more is the reason we're also retaining better. And I think we've established an awful lot of goodwill over the last few years in the manner in which we dealt with the various issues that we faced. And I would say not least in the manner in which we priced. It's -- as Palmer referenced earlier, I think we've been very transparent with our pricing. We've demonstrated the gross cost inflation. We've demonstrated the absolute pounds millions mitigation that we can deliver for our clients. And we've only sought to pass down that real net cost inflation after we can do everything. And we sought to offset the margin dilution through our own other initiatives. So I think that combination of sort of the approach that we've led to these various issues has left us in a good place with our client base. We think we've seen a bit more go out for retention in the last 6 months or so. And yet, we're sustaining these very positive levels of retention. So we feel good about where we are. And of course, yes, that will -- those positive levels of retention will underpin our growth over the next few years.
Palmer Brown
executiveA couple of more thoughts on the retention piece. As Dom mentioned before, the macro status helps on the retention side, just as you touched on earlier. But also, as you touched on earlier, with respect to Europe, we've done a lot to improve our processes and our focus within Europe. That's the region where we've seen the biggest step-up in terms of retention rates. And it's been a massive priority for us and it's great to see that come through. This is a record rate. We've kept it for several quarters now. We look at it on one hand is a record. On the other hand, if you look at it in the inverse, that means we're still losing upwards of GBP 700 million or so of business, and we think we can do better. So we take a very much of a micro focus on how we try to drive retention and that's paying off.
Operator
operator[Operator Instructions] We will now move to our next question from Harry Martin from Bernstein.
Harry Martin
analystA couple of questions from me. The first one is on Sports & Leisure within North America. Some of the commentary we've seen on [indiscernible] suggested the leisure season is running very well. So I wondered if you could comment on where that stands potentially next to the 14% organic growth for the entire North America business? Is the leisure running ahead? And then the second question is on new wins. Now that the key selling season in Education is, I understand, mostly over, where are we tracking relative to the GBP 2.5 billion annualized wins you did last year? And do you expect that to be flat or slightly up compared to last year or a little bit down?
Palmer Brown
executiveYes. On your first one, Harry, North America Sports & Leisure, you've heard from us previously that the consumer spending has been very strong -- surprisingly strong in that segment, and that is continuing. And we're not seeing any signs of weakness thus far. So that trend is staying consistent. Similar to the theme from prior conversations. You saw a massive reopening of Sports & Leisure really in the second half of last year. So you're starting to lap that a bit on the consumer spending within that, even though today continues to be strong. On the new win side of things, just as Dominic referenced before, over the last year, we're at GBP 2.5 billion. We've got a very strong pipeline. We're excited about the pipeline. We think this year can be a record-setting year for us. As you know, it's lumpy and the timing is unpredictable and uncertain, but we're always focusing on expanding that pipeline and raising our conversion rates. So it's something we feel good about.
Operator
operatorWe will now move to our next question from Jaafar Mestari from BNP Paribas.
Jaafar Mestari
analystI have 2, if that's all right. Firstly, on the environment you described today, just curious whether it means anything for the balance sheet? Is this an environment where you'd be fully comfortable with 1.5x net debt to EBITDA? Or would your preference B2B slightly below, like you're likely to [indiscernible] buyback at the end of the year until some of the remaining uncertainties have completely abated? And then just secondly, I wanted to come back on one prior question. So when margins were 6.5%, that was 100 bps below pre-COVID levels and you were describing precisely where that came from. And I think you were saying 40 bps drag from inflation, 40 bps drag from start-up costs, strong new business and then 20 bps drag from OpEx into the general capabilities, digital investments, et cetera. Is that a bridge that you have a basis now that you're close to 7% and -- or at 7% for H2? And start-up costs, in particular, and digital OpEx, are they being phased out as you expected or at least are they being better amortized with the higher revenue now?
Palmer Brown
executiveWith respect to the balance sheet, we've got a capital allocation framework that we apply. We start by looking at organic opportunities that comes in the form of CapEx. One thing to really call out there, we said at the half year, we expect the CapEx for the full year to be in the 3% to 3.5% range. We now expect that to be at the low end, so closer to 3% for the full year. Not exactly sure, again, that that's a permanent trend, it's something we're keeping an eye on. But certainly for this year, that's where we expect it to be. So first and foremost, we take advantage of organic growth opportunities. Then we look at inorganic mainly in the form of M&A. You'll see we've done about GBP 272 million or so of spend year-to-date. Very little in Q3. We are looking at a number of opportunities currently in all of our regions. Some of that may happen in Q4 or makes in into next year. We will keep an eye on the level of activity in the quantum there. And then any excess above the target leverage, we will return to shareholders. We do expect that target leverage to be in the midpoint of our range by the end of the year when we complete our current GBP 750 million buyback. We look at the landscape, including the M&A landscape, and we'll make some decisions there. So I think we'll look at it in the same way that we've been looking at it the prior 2 quarters. We are very cognizant of the interest rate environment and the raising of additional debt and what that does. So there's a constant balancing this there. On the margins front, Vicki touched on this a little bit earlier as well. I think at this point, it's more weighted towards the inflationary pressures. You are seeing a normalization of the mobilizations. So as that continues to move forward, that particular drag declines, but inflation has been stubbornly high for a while now. I think we've shown we can manage it fairly well through our mitigation efforts and partnering with our clients is a big piece of it as well. It's really hard to unpick that precisely, but it would be more weighted towards the inflationary aspect now.
Jaafar Mestari
analystAnd then just that extra bit on the digital OpEx and general investments in your global capabilities there. Is that something that [indiscernible] or is the 20 bps something [Technical Difficulty] long term?
Dominic Blakemore
executiveYes. I mean I think what's really important is we need to continue to invest in our business. We need to invest in sales, retention, operations. We need to have the best talent in the industry. We need to have digital and data-led solutions for our clients. And we're not going to hold back on those investments. They're absolutely the right things to do. I think as you rightly said, we're touching 7% in the second half. We've made significant progress this year on margin. I think it's 50 bps on a full year basis despite the very significant inflationary pressures, and we will continue to make margin progress from here, and that will be in addition to higher growth. I think we just need to balance the need to invest in this business to sustain mid- to high single-digit growth over multiple years and to maximize the opportunity that we think of a very, very exciting market. I mean this market today has got more growth opportunity than I've ever seen.
Operator
operatorAnd as there are no further questions in the queue, I'd like to hand the call back over to Dominic Blakemore for any additional or closing remarks.
Dominic Blakemore
executiveYes, I'd simply just say thank you very much for joining us. We wish you a very, very restful and enjoyable summer, and we look forward to speaking with you again in November. Thank you.
Operator
operatorThank you. This concludes today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.
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