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Fitch Affirms Compass Group at 'A-'; Outlook Stable
October 24, 2017 / 3:40 PM / a month ago

Fitch Affirms Compass Group at 'A-'; Outlook Stable

(The following statement was released by the rating agency) MILAN/LONDON, October 24 (Fitch) Fitch Ratings has affirmed UK-based food services company Compass Group plc's Long-Term Issuer Default Rating (IDR) and senior unsecured instrument ratings for Compass Group plc and Compass Group International B.V. at 'A-'. The Outlook is Stable. The rating and Outlook remain supported by the stable operating performance of Compass through the cycle, its diverse customer base, strong geographic diversification, high retention rates and a proven ability to deliver efficiencies and cost savings. Compass's cash-generative business model and strong financial flexibility also support the ratings. The ratings are constrained by shareholder-friendly returns, such as the recent distribution, funded with debt, of a GBP1 billion special dividend. This reduces deleveraging prospects. However, the risk of a change in financial policies is balanced by management's reiterated commitment of maintaining a leverage ratio (net debt/EBITDA) of around of 1.5x. KEY RATING DRIVERS Stable Resilient Business Model: We expect steady organic revenue growth, coupled with minor bolt-on acquisitions to drive revenue of over GBP24 billion by FYE19 (year ending September). Compass's large scale, strong brand name, sector barriers to entry and high retention rate support our view of sustained top-line growth. The group has demonstrated its ability to offset macro-driven operating pressures through the maintenance of strong client-retention rates (94.1% in 2016), the active management of its cost base and its 'soft' (non-food) support service offering in parts of the business. Strong Diversification: Fitch expects the global long-term trend towards outsourcing to support Compass's continued growth. Healthy performance has been supported by strong new business wins in North America in recent years and we expect this trend to continue. Continued weaknesses in the rest of world segment has been driven by the offshore and remote business and offset by organic good performance in the other businesses. This strong diversification supports our view of a strong business profile for Compass, with the group able to offset difficulties in some regions or business areas with steady growth elsewhere. Steadily Improving Margins: We forecast that EBITDA margins will move towards around 9.6% by FY19, driven by ongoing benefits from economies of scale, efficiencies through its management and performance framework (MAP) programme, a focused management team as well as recently completed efforts to reduce the cost base in the offshore and remote business. This should result in improving cash flow and flexibility for the business, underpinning our Stable Outlook. Healthy Cash Conversion: Compass has a sound track record of converting profits into cash, given the asset-light nature of its business, and generally limited working capital requirements. However, given the aggressive shareholder returns policy, free cash flow (FCF) margins remain weak for the current rating level, albeit partly offset by stability through the cycle. We assume that share buybacks will continue and factor in spending of between GBP200 million and GBP300 million per year in addition to steadily increasing dividends. Shareholder-Friendly Policy: Compass has historically provided returns to shareholders through a combination of annual dividends and share buybacks. In 2017, the group announced a special dividend of GBP1 billion, to be funded substantially by new debt issuance. This is the group's second large special dividend in four years. We view this as an indication that the group will continue with such shareholder returns in the future. However, we also note that this is within the framework of management's commitment to maintain net debt/EBITDA at or about 1.5x, showing a willingness to protect its current metrics. Stable Credit Metrics: We expect leverage to remain fairly stable over the next three years, with funds from operations (FFO) adjusted gross leverage falling slightly to around 2.5x by FYE19 from 2.8x at FYE17, which is comfortable for the current rating level. This is underpinned by our expectation that Compass should maintain a leverage target of net debt-to-EBITDA of 1.5x. In addition, financial flexibility is good with FFO fixed charge coverage comfortably above our minimum expectation of 4.5x consistent with the 'A-' IDR. DERIVATION SUMMARY Compass is rated one notch above its closest peer Sodexo SA (BBB+/Stable) as its profitability and leverage metrics are moderately stronger and we expect leverage to be slightly lower over FY17-FY19. We also view Compass's business profile as slightly stronger than that of Sodexo. Compass is further along its MAP framework, which has led to margin benefits and generated useful resources to support efforts in delivering stronger organic growth. Sodexo's profit margins should also improve, following the completion of its adaptation and simplification programme, but we forecast that these will remain below those of Compass. Smaller peer Elior SA (BB/Stable) displays a weaker business and financial profile than Compass and Sodexo, which is reflected in their multi-notch rating differential. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Approximately 15% top-line growth in FY17 organically and from acquisitions, accentuated by large positive FX impact. Low-to mid-single digit growth driven by a mix of organic growth and bolt on acquisitions thereafter; - Steady improvements in profitability, with EBITDA margins approaching 9.6% by FY19; - Capex remaining at about 3% of sales per annum; and - Dividends growing steadily year-on-year, as well as other shareholder distributions but with net debt/EBITDA ratio remaining at about 1.5x. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action While we expect it unlikely over the rating horizon, a positive action in the future could be considered if the following is met: - FFO adjusted gross leverage remaining below 2.0x on a sustained basis (FY16: 2.6x). - Improvement in FCF margins towards 5% (FY16: 1.9%). - FFO fixed charge coverage remaining above 8.0x on a sustained basis (FY16: 7.3x). Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Negative organic sales growth and significant EBITDA margin erosion. - Continuation of an aggressive financial policy or operational weakness leading to FFO-adjusted gross leverage deterioration above 3.0x on a sustained basis. - FFO fixed charge cover below 4.5x. - Insufficient FCF (pre-dividends) from FY16 to fully cover shareholder returns. LIQUIDITY Liquidity is satisfactory. Compass had unrestricted cash of GBP346 million at FY16, together with access to GBP1 billion of undrawn committed bank facilities due 2021. Its debt maturity schedule is even and refinance risk is low with no significant debt redemptions before February 2019. Contact: Principal Analyst Patrick Durcan Analyst +44 20 3530 1298 Supervisory Analyst Giulio Lombardi Senior Director +39 02 8790 87214 Fitch Italia S.p.A. via Morigi 6 20123 Milan Committee Chairperson Raymond Hill Senior Director +44 20 3530 1079 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments - Rental expenses capitalised for adjusted leverage calculation, using a multiple of 8x Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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