Compass Group PLC

LSE:CPG

Earnings Call Transcript 2018-Q3

[Operator]

Hello, and welcome to the Compass Group Third Quarter Trading Update Call. [Operator Instructions] Just to remind you, this conference call is being recorded. Today, I am pleased to present Mr. Dominic Blakemore, CEO; and Mr. Johnny Thomson, Group Finance Director. Please go ahead with your meeting.

[Dominic Blakemore, Group Chief Executive & Director]

Good morning, ladies and gentlemen. Thank you all for dialing in. With me this morning, I've asked Group Finance Director, Johnny Thomson. I'm sure you've all read the statement, so I'll give you a brief overview of our performance and outlook before opening the call to questions. Compass continued to trade well, and our full year expectations are unchanged. Organic revenue grew 5.7% in the third quarter or 5.1% if we exclude the impact of Easter. Performance is driven by strong net new business in North America and acceleration in Europe and good progress in Rest of the World. We continue to generate efficiencies across the group, which resulted in margin improvements in the third quarter, and we remain on track to deliver modest margin improvement for the full year. Looking at each region in turn. Performance in North America continues to be strong with organic revenue up by 7%, or 6.6% excluding the effect of Easter. We saw particularly strong growth in Business & Industry, Vending, and Healthcare, which was partly offset by the impact of timing of certain Sports & Leisure events. These will benefit in Q4 along with the mobilization of some good contract wins in Education. Year-to-date margins were stable. Organic revenue in Europe grew by 3.2% in the quarter, or 2% excluding Easter, driven by an acceleration of net new business in the U.K. Although the benefits of the cost actions taken to offset above-average inflation in the U.K. are coming through and benefiting margins, they were offset by a more challenging volume and cost environment in the U.K. In Rest of World, organic revenue increased by 3.1%, or 2.7% excluding Easter. Growth was driven by strong performances in Turkey, India, China and our Spanish-speaking Latin American businesses. Less-than-expected efficiencies and improved overhead leverage in growing markets results in these strong margin improvements in the quarter.A quick update on currency. If current spot rates continue for the remainder of the year, foreign exchange translation would negatively impact full year 2017 revenue by around GBP 984 million and operating profit by GBP 77 million. In summary, Compass continues to have a good year. Performance in North America is strong. Europe is accelerating as expected. And Rest of World is progressing well. Better-than-planned margin improvement in Rest of World is offsetting a more difficult volume and cost environments in Europe. As a result, our full year expectations are unchanged with organic growth above the middle of our 4% to 6% range and modest margin progression. In the longer term, we remain excited about the significant structural growth opportunities globally with potential for further revenue and margin improvement along with continued returns to shareholders.Thank you. And now we'd be happy to take your questions.

[Operator]

[Operator Instructions] We will take our first question today from Jamie Rollo of Morgan Stanley.

[Jamie David William Rollo, Managing Director]

A few questions, please. First, could you just elaborate a bit more on what's happened in the U.K., particularly the comments on the recent volumes tier ratings? So what's changing? Is that a market issue? Is that an economy issue? And historically, Compass has dealt very well with unforeseen events, but it looks like this is perhaps a tougher environment. So what's happening, please? And then the other question on the Rest of World margin performance where Q3 looks very good up around 100 basis points. I'm just wondering how sustainable that is, particularly if we look at margin progressions for 2019?

[Dominic Blakemore, Group Chief Executive & Director]

Great. Thank you, Jamie, and I'll hand those 2 over to Johnny.

[Jonathan Thomson, Group Finance Director & Executive Director]

Well, first thing I would say, Jamie, is that we're pleased with the actions we have taken and we discussed at the half year. We're definitely seeing the benefits -- in U.K., I'm talking now. And we're definitely seeing the benefits of those actions coming through. However, as Dominic said earlier, we are seeing a more challenging trading environment in the U.K. than we expected. Perhaps the cost inflation continues to be higher than we had anticipated. But I think, more importantly, we are seeing our like-for-like volumes coming off. And as you know, the drop-through on volume to our profit level and margins is fairly significant. So what that means, of course, as you point out correctly is that we're having to work hard. And therefore, we're still confident that the U.K. margin will come through, perhaps a fraction later than we anticipated in the half 1, but it will come through. And therefore, what I think you'll see is quarter 4 European margins much stronger perhaps even into positive, and therefore, a nice carry into next year. But it's definitely a tougher environment in the U.K. In terms of the Rest of the World, we're really pleased about the margin progress. I think I've highlighted that just over the last few reporting periods. We obviously did the restructuring, but through the commodity cycle, we haven't been standing still. We've been working hard on pricing and productivity to make sure that our margins continue to face into the commodity cycle. As that cycle starts to ease, of course, we then see the benefits of that coming through. On top of that, as Dominic mentioned earlier, we do have the benefit of leverage as some of those businesses now come back into growth. Looking out further on margins in Rest of World, of course, you'd expect me to say these kind of margins aren't necessarily sustainable. We do have the benefit in these quarters of the construction project in Australia, which has taken longer to flow into production than we expected. And therefore, we're having higher-than-expected margins than we anticipated. That will roll off, and therefore, our carry-on Rest of World margins won't be quite at this level.

[Dominic Blakemore, Group Chief Executive & Director]

And Jamie, I just add to that a couple of points. I mean, firstly, we're really pleased with the growth in the U.K. So the growth in the U.K. in the third quarter has accelerated, and, we anticipate that acceleration into the fourth quarter and next year. So I think that's very important. I think secondly, it shouldn't be a surprise that volumes are slightly under pressure. We're seeing it on the high [ Street ], and we are taking actions and monitoring that as we go. And finally, I think it's really important that we manage our total portfolio of businesses, and therefore, we're seeing strong performance in Rest of the World allowing us to offset that in the U.K. And as we look forward as we said his morning, we continue to expect margin progression as we go ahead.

[Jamie David William Rollo, Managing Director]

So the U.K. volume issue is really a consumer marketplace issue? There's something specific like contract catering or Compass?

[Dominic Blakemore, Group Chief Executive & Director]

We don't think so. I mean, we're obviously tracking it. And it's -- We're seeing those negative volumes slightly accelerate in the third quarter. I think we're seeing it on the high Street. Perhaps part of that is price related, I think partly, it's consumer confidence. And perhaps, there's a little bit of business confidence in there as well at the moment. So we're just being careful as we work through this environment, but certainly not Compass or contract catering related.

[Jamie David William Rollo, Managing Director]

Okay. And on 2019 margins for Europe, if this year's guidance moves from minus 15 to minus 40, but the U.K. is on track, just a bit slower to get those savings through, should next year be up 25-or-so?

[Jonathan Thomson, Group Finance Director & Executive Director]

No. This year, just to be clear, we're moving the guidance for Europe as a whole to minus 50 on Europe. As I said a bit earlier, we will see some progression in quarter 4, but I think once you get into 2019, you should expect us to get back to what we would typically see from a European model, which would be modest, say, 5-ish bps worth of margin improvement in Europe.

[Operator]

We take our next question from Lena Thakkar of HSBC.

[Lena Thakkar, Analyst]

I think I've got 3 questions as well. So firstly, just in terms of this Sports & Leisure impact in North America, I wonder if you could quantify that for us in the quarter? Secondly, sorry for going back to the U.K. like-for-like volumes again but just slightly baffled about that. Is it got any to do with the warm weather? Or are you sort of seeing any structural changes with people working from home more or anything, so the football -- I'm just trying to sort of -- the High Street seems like set for a structural issue that's happening. So I'm just trying to understand better why those volumes will have fallen. And then finally, just in terms of cost inflation and pushing that through in your contract, can you sort of remind us as to how the mechanics work and why in some cases it seems to be quite difficult to pass through either staff or food cost inflation in those contracts?

[Dominic Blakemore, Group Chief Executive & Director]

Let me take the first couple of questions, Lena, and I'll pass on to Johnny on cost inflation. I mean, firstly, we're not going to quantify the impact of the Sports & Leisure event timing. There are a couple of significant impacts where Major League Baseball season is starting in quarter 4 this year, whereas it started in quarter 3. I think there's a major motor racing event in Las Vegas, which again falls into quarter 4 rather than quarter 3. So I think we're very clear that there is cause and effect there. I think more important, we anticipate that North America's growth rates on a full year basis will accelerate from the 7.2% we're seeing today possibly by a further 20 basis points-or-so. That implies a run rate in the fourth quarter that will be towards 8%, which I think is very, very exciting, driven not least by the timing of Sports & Leisure but also some great wins in the Education sector, which we'll mobilize in the fourth quarter. So I think that's really important and we're very excited. And I don't think we should get hung up on the timing of Sports & Leisure events because that can impact quarters with reasonably small numbers. So I think that trend into the fourth quarter and beyond is what's important. Second, on the U.K. like-for-like, I slightly disagree with you on the point of that, the high Street impact. I think the high Street impact is a lot about the cost inflation that we're seeing at the moment as well as some consumer trends. And I do think that, that is perhaps also playing into [indiscernible] captive catering environment. Certainly, you may be -- you may have a point on weather and World Cup, but if that's the case, then perhaps things will get a touch better, but I think we're more focused on what we think is an underlying trend of slightly lower spend and slightly lower footfall into our restaurant.

[Jonathan Thomson, Group Finance Director & Executive Director]

Yes, and I'll just pick up on the cost inflation and pass-through points contracting. The first thing I'd say is that we've focused first and foremost on mitigating cost inflation through our own actions on cost, and that's a very important part of our model before we get to pricing to ensure our clients the best value proposition. And we've always been ahead of that and done that quickly in the past, and we expect to do so in this case as well. Coming back specifically to your question, I mean we have, in general, 3 different cost type -- 3 contract types. They would be cost plus P&L and fixed price. In the first 2, while we have some negotiations with clients to do, in general, we have much more sovereignty of pricing, and therefore, it's easier for us to pass it on. In the last case, the fixed price case, we have much more negotiation to do with our clients. And therefore, it can take just slightly longer to do, and that would -- I would say, would be particularly the case in the U.K. and would be particularly the case in some of our support services contracts, which are much more labor orientated and do take longer to negotiate.

[Operator]

We take our next question from Kean Marden of Jefferies.

[Kean Marden, Equity Analyst]

Just touching on Johnny's last comment there, so could you maybe elaborate on the relative to the trading position in the U.K. support services businesses versus food. So I guess, have you seen a profit shortfall, rotating shortfall in some of the noncore businesses that you're looking to divest?

[Dominic Blakemore, Group Chief Executive & Director]

Yes, I mean, those noncore businesses are, what, just around 10% of our total U.K. revenues. The trading has been a touch more difficult. As Johnny outlined, yes, the cost inflation environment is more difficult to manage in that particular part of our business. I'd say it's probably slightly below our expectations for the year. And as we said before, we [are in] ongoing processes to look at how we might exit or sell those businesses.

[Kean Marden, Equity Analyst]

And I presume if you have any comments to make regarding disposal process, then you would've made them in today's statement?

[Dominic Blakemore, Group Chief Executive & Director]

Yes, I mean, as we said at the half year, we are evaluating those businesses across the group that we do want to exit ourselves. We started on that process. There's nothing to report in terms of our quarter 3, although since quarter 3, we have sold a small business in North America. So it's started. We would expect by November to be able to announce a few more. Although, of course, that will depend on the circumstances of each of the deals that we're doing, but I would hope that we can. And then the rest will flow through into 2019, but it's very much on track with what we expect.

[Operator]

We now move to David Holmes of Bank of America Merrill Lynch.

[David Andrew Holmes, Research Analyst]

I just wanted to touch on North American organic growth. You seem really confident on the acceleration into Q4 and comments on the pipeline have been very positive. So how do you think about that momentum carrying through into 2019?

[Dominic Blakemore, Group Chief Executive & Director]

Yes, I mean, you're right. We are anticipating a strong fourth quarter. Obviously, a little bit of that is timing as we said earlier today. What we will see though is we're going to see some good growth coming through in the higher ed sector in particular, but we'll also see the runoff of some of the big health-care wins that was a feature of our growth during the course of 2018. So I think in the round, we continue to look at momentum in the U.S. sort of broadly in line with where we've been this year so toward the 7% level, and that remains our expectations again for next year.

[Operator]

We now move to Richard Clarke of Bernstein.

[Richard J. Clarke, Research Analyst]

Two questions from me. Just -- you are retaining your guidance on the modest margin progression for the full year, and you clearly taken down the Europe guidance at the same time. Has anything across the group softened a little bit? And is that being offset by currency, per se? If you hadn't had the $1 boost, would you be able to stick with your modest margin progression? And then the second question is just is there any update on the new CFO and the process in sort of looking for a new CFO at this point?

[Dominic Blakemore, Group Chief Executive & Director]

So firstly, let's be absolutely clear. We are maintaining our margin guidance for the year as we have done throughout the year. I hope we made it clear today that, yes, Europe is a bit tougher, but we're doing better in Rest of World. So the portfolio is allowing us to offset that. It isn't about FX as we obviously -- we change our guidance as a result of the weakening of Sterling against the numbers we've previously given you. So that flows in addition to the guidance we've given. So hopefully that clarifies the point. But absolutely, we are maintaining our margin guidance. We have made progress in the third quarter. We have some modest margin progression in the third quarter, and therefore, we've improved in the year-to-date, and we expect to make a few basis points of margin progression on a full year basis. With regards to the CFO, we have commenced that search, it's underway, and obviously, we will update you as we go forward should there be any news. Obviously, we have -- Johnny's alongside me and here with me until the end of this calendar year and remains totally committed.

[Operator]

Hello, Mr. [ Barris? ]

[Unknown Analyst]

I had 2 questions please on margin. Just a big-picture thing. Looking at the math, I was estimating that to get to slight growth for the full year, you'd need about 20 basis points positive in Q4. Does that sound about right? And will that all come from Europe? And then the second question was just if you could give a better guidance on Rest of the World margin in the same way that you did to the question in Europe earlier.

[Jonathan Thomson, Group Finance Director & Executive Director]

Yes, your first question, you're pretty much spot on, on the 20 basis points, however, it's not all coming from Europe. As I said earlier, we're anticipating and positive about Europe improvements in the fourth quarter on margin. But we're also carrying a very strong margin performance from Rest of the World into quarter 4, too. So we feel really good about the quarter 4 performance, and that's why we're confirming our full year guidance. In terms of Rest of the World, as I said earlier, we've got 100 basis point-ish in quarter 3 and quarter 4. That's not going to be sustainable into next year. There are some -- your underlying improvements, which will continue, which I mentioned earlier in the call. However, we are anticipating that a big construction project in Australia will move into production either quarter 4 or quarter 1 next year. And that will significantly bring Rest of World margins down.

[Operator]

We now move to Tim Ramskill of Credit Suisse.

[Timothy Ramskill, Research Analyst]

Three questions from me, please. Maybe, Johnny, you could just go back to that point about the contract in Australia in terms of kind of maybe just a bit of help in terms of how much a margin drag that might have but also what that might help to contribute in terms of Rest of World growth next year? Second question was around the sort of the plan circa 5% exit that obviously you talked about in H1. I think a number of investors have been asking kind of what the financial implication of that might be. Presumably, I know you've kind of said these are sort of decent margin businesses, but they're obviously sort of in subscale territories or businesses where margins aren't potentially going to get any better. So how would you expect that 5% exit process net of some disposal proceeds as well to sort of flow through in terms of an earnings impact? And then the final question is maybe if you could just take the opportunity to give us your thoughts on the outlook for Europe, so more medium-term given -- it has been a little bit volatile over the course of the last few years. I know it's tricky to read, but what's your current thinking on the medium-term prospects?

[Dominic Blakemore, Group Chief Executive & Director]

[indiscernible] Tim, let me take the second part of the question, and we'll come back to the question on the impact of the contracts in Australia. Just with regard to the exit program, I mean, yes, we talked about it being up to 5%. I think that remains broadly the case. We have got, as we have said, a number of ongoing processes. So you should expect us to be able to provide a fuller update when we come to the year-end. We said that they are broadly in the round margin neutral to the group. There is obviously a range of operating margins in those particular countries or subsectors. And so depending on the timing, you will see the impact of those. And I think it's clearly fair to say that we're unlikely to achieve a Compass multiple on those businesses. But we will update you as we go on the proceeds we receive for the business. I think what's really, really important in all of this for me is that it's quite a long tail. It is distractive of management. And I think that this will really allow us to focus on our core businesses where we see better, medium- and long-term growth prospects, better medium and long-term margin opportunities, and it will allow us to deploy the best practice processes more consistently across that smaller core of markets. So I think that's where the benefit absolutely becomes in my eyes. But we will give you a fuller update when we get to November on that. Secondly for me on Europe and the medium-term prospects, I think things are looking within Continental Europe, so excluding the U.K. from a growth perspective, slightly better for us. So we have had a dull year this year. We're exciting a better fourth quarter. And as it looks today, our retention rates in a number of the major European markets are strengthening. We continue to win good levels of new business. So I think we're hopeful that we will see an improved performance in Continental Europe as we look forward into next year and continue the efforts we talked about in terms of building out subsector brands and creating the scale that allows us to be more efficient in the European markets. So I think that's something that we will hopefully be talking to you about as we move forwards. And then finally, on the OR contract in Australia, Johnny?

[Jonathan Thomson, Group Finance Director & Executive Director]

I think firstly I'd say, Tim, is that we're really excited about the way Rest of the World business is developing. We've obviously had 2 or 3 years of quite a tough environment, and we've been battling that hard, and we're very pleased to see some of the fruits of that labor coming through. And as we go forward, that will come through stronger in the top line. And we'll continue to have margin improvement. As I said earlier, it won't be quite at these levels. First of all, because, of course, we'll be lapping some of the benefits that we'll be taking this year from the restructuring. But as you point out also because of the move from construction to production in Australia, I would say that our guidance for next year to give you a steer, our Rest of World margins should improve by around about 20 basis points, which again, we feel very positive about.

[Operator]

We will now take our final question today from Jarrod Castle of UBS.

[Jarrod Castle]

There's something which is kind of topical at the moment in the press, but going into 2019, it seems like the government's potentially making contingency plans for I guess a hard Brexit. And I'm very interested just to get your thoughts on obviously a core part of your business is supply chain management and just getting idea of how much of the U.K. input is from kind of local producers versus Europeans and how you're thinking about that. Secondly, I don't know if you have or if you can just give any further color on how your CapEx for sale is progressing? Is it on track versus your guidance at 1H. And then just lastly, I'm sorry, I missed the first part of the call, so I don't know if someone's asked this, but just in terms of your energy and commodities businesses, is that coming back just given the sustained relatively high oil price?

[Dominic Blakemore, Group Chief Executive & Director]

So Jarrod, let me tackle the first question, then I'll hand over to Johnny for the CapEx and commodities question. Firstly, with regards to -- you're absolutely right, the media coverage around some contingency plans for food and food and beverage management by the government. I mean, it's obviously something that we've been thinking about and looking out for a while. Our supply mix is broadly sort of 60%, 65% U.K. sourced, with 35%, 40% either Europe or other, and that would be sort of direct and indirect supply. We're obviously looking at what different deal scenarios could mean, and therefore, the contingency planning we need in place to address that. So some of that will be about understanding how we can swap product, how we can source U.K. product, how we can build inventory where necessary, and also where we can reach and agree longer-term supply deals. So there's a combination of actions going on. The planning is in hand, and I guess we will just have to work with whatever outcome of the negotiations emerges. But I think, rest assured, we are certainly in the planning and contingency mode.

[Jonathan Thomson, Group Finance Director & Executive Director]

And then just on the CapEx, I would anticipate that our CapEx this year would be at the top end of the range that we discussed at the half year, so around about 3.5%. I mean first of all, of course, you knew about the Dodgers investment that we made earlier in the year, and we've talked about. But as Dominic also mentioned, we've had some real exciting wins in the Education sector in North America with a little bit of CapEx in quarter 4, too. So we should be right there or thereabouts on the top end of the guidance on CapEx. As we look beyond that, we still stick to that guidance of up to 3.5%, probably a fair assumption in the absence of the Dodgers would be somewhere between 3% and 3.5% into next year. Just on your commodities question, I mean, year-to-date, our commodities business has declined by about 2%, which is actually a little better than we'd expected. As we said earlier, the roll-off of the construction process in Australia has just taken a little longer than we expected. So as we look into next year, that will roll off and will have an impact on how quickly our business gets back into growth. However, in the medium term, we'll expect to be lapping and, therefore, that business to come into growth, but what we're not seeing necessarily is a significant amount of capital reinvestment from our clients. And therefore, I would expect that growth to continue to be modest. We still have a great business, and I guess, having come through this, it's still even now a much smaller part of the group as well, around 5%. But it will come into growth in the latter part of 2018/'19.

[Operator]

Ladies and gentlemen, that will conclude today's conference call. On behalf of the Compass Group, we'd like to thank you for your participation. You may now disconnect.