Compass Group – expect a two-speed recovery for hospitality

Confirmation from the government that the easing of Covid restrictions is on track means the hard-pressed catering and hospitality sector can look forward to some good news, as diners, office workers and holidaymakers return to a semblance of their pre-pandemic habits. That means the industry, which was heavily reliant on inflows of workers from the EU, can then get back to its pre-pandemic concerns over the post-Brexit visa regime. With plenty of workers enjoying the experience of working from home, there is also the question of whether the days of feeding large buildings full of people are over, as companies downsize office space and move towards a mixed working model.

Downsized and recapitalised

There had already been major structural changes in hospitality prior to 2020 – for clarity we also include casual dining in this definition. A private-equity-fuelled restaurant bubble had burst just prior to the pandemic – high streets full of abandoned chain restaurants were testament to an unsustainable gold rush. In a way, the health crisis accelerated the necessary process of downsizing capacity and recapitalising balance sheets. For instance, Restaurant Group (LSE: RTN), managed by ex-HBOS chief executive Andy Hornby, got a successful £175m placing away in March, with the proceeds used to pay down debt and cover restructuring costs. The doubling of the share price since the start of the year confirms that the market sees the potential for casual diners to flock back once restrictions are eased and lockdown savings are spent.

The big players in catering and hospitality have also been reorganising themselves in anticipation of a bumper summer. Whitbread (LSE: WTB), despite posting a 70 per cent fall in sales, is boosting its net debt pile by 11 per cent, as it plans to spend over £350m on opening its hotels and ramping up marketing for an expected summer of stay-at-home holidaymakers. Whitbread is clearly banking on the recovery in the UK market outpacing the sluggish year, so far, in Germany, as that key market grapples with a patchwork of often contradictory Covid-19 restrictions and a lumbering vaccination programme.         

Contract catering’s continuing conundrum

What no one can really predict is whether the enforced change in our working lives translates into permanently lower sales for contract caterers as office spaces change. Compass Group (LSE: CPG) is the only large major listed company left standing in the UK after Mitie sold out of its contract catering business in 2019. The company had already recapitalised with a £2bn placing in 2020 so, financially at least, it can wait out a slow return to normality in the sector. It will be starting from what can charitably be described as a very low base – The Caterer reports that sales for contract caterers nearly halved in the first three months of this year.

The half-year results largely confirmed that analysis. Compass posted a predictably huge fall in first-half revenues, down by more than 30 per cent to £8.4bn, with pre-tax profits slashed to £133m from £787m the year before. However, the results came well within market forecasts and investors noted management’s cautious optimism for a significant improvement in the third quarter, with operating margins edging higher to 4.2 per cent.

The recovery for Compass, when it comes, is likely to be as multi-speed as the rest of the catering and hospitality sector. The half-year results highlighted that the business and industry segment was running at just 60 per cent of its comparable 2019 sales, with the overall business generating 71 per cent of the 2019 top-line. This business sector is the most sensitive to the fundamental changes in work habits that could make recovery far slower.

Compass must wait for some sort of return to normality before an accurate judgement can be made about its prospects. The fall in earnings makes EPS forecasts largely redundant. However, Compass’ balance sheet is flashing a current ratio of 0.94, just under the threshold for positive cash generation. With analysts at Hydra forecasting that corporate demand for food service will be structurally smaller, Compass needs to find new avenues for growth in the year ahead. Hold.

Last IC View: Hold, 1,422p, 03 Dec 2020