Morning Note: Market news and updates from Compass and Imperial Brands.

Market News

US equity markets rose last night – S&P 500 (+0.5%), Nasdaq (+0.8%) – and Treasuries steadied – the 10-year yields 4.44% – ahead of today’s CPI data. Gold ticked up to $2,363 an ounce. The inflation print is expected to show price pressures moderated in April, with the headline figure at 0.4%. Bloomberg Economics anticipates the core reading will be the lowest yet this year. Meanwhile, Fed Chair Powell said the Fed must be patient and wait for proof that inflation continues to cool, reiterating the need to keep rates higher for longer. 

This morning in Asia, markets were mixed: Nikkei 225 (+0.1%); Hang Seng (holiday); Shanghai Composite (-0.8%). China is considering buying millions of unsold homes to support the property market, people familiar said. Local governments would be asked to purchase units from distressed developers at steep discounts using loans provided by state banks. The offshore yuan strengthened.

The FTSE 100 is currently trading 0.6% higher at 8,472, while Sterling buys $1.2598 and €1.1631. The oil price moved up to $82.68 a barrel before the IEA report. Copper surged to a record in New York, driven by a short squeeze. Traders snapped up call options on the Comex, with the premium widening on demand for protection against a further rally.

Source: Bloomberg

Company News

Compass Group has this morning released results for the first half of its financial year to 30 September 2024. The figures were in line with market expectations and the dividend was increased by 15.6%. As expected, there was no change in the share buyback programme given the step up in M&A. The group raised its full-year guidance, although again this was expected by the market and, in response, the shares have seen a little profit taking in early trading. 

Compass is the world’s largest foodservice company, operating in around 30 countries, serving over 5.5bn meals a year. The group also operates a targeted support services operation that accounts for 15% of revenue. From this financial year, the company is reporting in US dollars.

During the six months to 31 March 2024, revenue grew by 11.0% to $20.9bn. Organic revenue – a combination of like-for-like volume growth, price, new business, and client retention – grew by 11.2%, above the consensus forecast of 10% and ahead of the run-rate for the company’s full-year guidance of high single-digit growth. This was despite continued inflationary pressures and some macroeconomic uncertainty.

The “flight to trust” continued and the group benefitted from strong outsourcing trends, with net new business growth of 3.7%. First-time outsourcing trends continued, accounting for 50% of new business wins, and client retention remained strong at 95.8%. Compass saw like-for-like volume growth of 2.5% and pushed through 5% pricing growth. Volume growth is expected to moderate as the group laps strong comparatives across the rest of the year.

The group’s largest region, North America (c. two thirds of revenue), grew by 10.9% in organic terms, while the margin rose by 40 bps to 8.2%. In Europe, the group has continued to enjoy a step change in its performance – organic revenue was up 12.4% – which has benefited from growth initiatives as well as favourable outsourcing conditions. The Europe margin was up 20 bps to 5.8%. The Rest of World region grew by 10.6% and saw its margin rise by 80 bps to 5.3%.

The group has continued to reshape its portfolio to focus on growth opportunities in attractive markets. Last year, it exited nine tail countries and during the latest period another four. An agreement to exit Brazil is subject to regulatory approval.

The group’s margin grew by 50 basis points to 7.1%, in line with the market forecast, driven by operational efficiencies and appropriate levels of pricing to mitigate the sustained inflation headwinds. Operating profit grew by 18.7% to $1,474m, in line with the consensus expectation.

Cash conversion was 48% and the business continued to generate strong free cash flow of $704m in the period. The group spent $693m on capex, 3.3% of revenue.

As the group focuses on the significant structural growth opportunities in its core markets, it has stepped up its M&A activity to expand its portfolio of brands, focused on digital innovation and delivered-in solutions. Net acquisition expenditure in the latest half-year was $373m. After the period end, the company completed the purchase of CH&CO, a provider of premium contract and hospitality services in the UK and Ireland for an initial enterprise value of $600m. The company generates revenue of $570m across a range of sectors, including Business & Industry, Sports & Leisure, Education, and Healthcare, and will complement the group’s existing footprint. Although a deal of this size may reduce the amount of excess cash flow available for share buybacks, we believe reinvesting in the core business is good capital allocation and will generate upward pressure on earnings forecasts.

Financial leverage was 1.4x net debt to EBITDA, within the medium-term target of 1.0x-1.5x. In response, the group is buying back its shares and has completed half of its $500m (£410m) programme, which is expected to be completed in 2024 subject to M&A activity. The group is also paying an attractive dividend – a half-year payout of 20.7c (16.5p) was declared today, up 15.6% versus last year.

Overall, Compass continues to show it has the flexibility to weather the uncertain macro-economic environment whilst continuing to invest in the business to enhance its competitive advantage, support long-term growth prospects, and further consolidate its position as the industry leader in food services. Investment in digital expertise is bringing benefits of increased new business wins, higher customer participation and transaction spend, reduced food waste and food cost, and increased productivity and staff retention. Although there are threats – permanently increased levels of working from home and online learning, higher unemployment in a downturn, and increased competition from delivery providers – we believe the company is well placed to cope, with the more cyclical Business & Industry unit now a smaller percentage of revenue (a third vs. a half) and a higher level of volume protection in contracts.

The scope for growth from first-time outsourcing and share gains is significant, and the group currently has an excellent pipeline of new business. As the largest player (albeit with less than a 15% share) in the $300bn global market, Compass is well placed to consolidate its position as a trusted provider, able to offer clients and consumers safe and innovative solutions. Scale provides a vital advantage over smaller players, while corporates and other institutions will be more open to outsourcing as they seek improved health and safety protocols, resilient food supply chains, and financially strong suppliers. This is especially the case in the health and education sectors which previously used in-house catering providers.

Given the strong start to the year, the company has raised its guidance for the financial year to September 2024: underlying operating profit growth ‘towards 15%’ on a constant currency basis (up from ‘towards 13%’ previously) delivered through ‘towards 10%’ organic revenue growth (versus ‘high single-digit’ previously) and ongoing margin progression. Net new business growth is expected to grow by 4%-5%, with H1 slower than H2. Given the growth opportunities, the group expects capital expenditure to be around 3.5% of underlying revenue in 2024, with net M&A expenditure likely to be higher than in 2023.

Overall, the company remains ‘excited’ about the significant structural market opportunity globally. It expects to sustain mid-to-high single-digit organic revenue growth (i.e., 5%-8%) and return to its historical pre-Covid margin (7.5%). This will drive profit growth above revenue growth, allowing shareholders to be rewarded with further returns.

Source: Bloomberg

Imperial Brands has this morning released results for the half-year to 31 March 2024. The figures were in line with market expectations and the group remains confident it will deliver full-year results in line with guidance. Shareholder returns through dividends and buybacks remain attractive. In response to today’s news, the shares are up 3% in early trading.

Imperial Brands manufactures and sells cigarettes, fine cut tobacco, smokeless tobacco, cigars, and next generation products (NGP). The main brands include Winston, Davidoff, L&B, West, and JPS. The group’s five-year business plan is focused on three pillars, with investment focused on markets and brands with the greatest opportunity for value creation.

The primary driver of medium-term value creation is a revitalised tobacco business focused on the group’s top five (priority) markets – US, Germany, UK, Australia, and Spain – which represent 70% of combustible operating profit. Although this means there is some concentration risk, the company believes these are attractive markets, especially Germany and the US which are more ‘affordable’ providing scope to increase price.

The second strand focuses on the broader tobacco portfolio where there are additional opportunities to drive growth whilst realising operational efficiencies. An ERP roll-out will replace 60 legacy systems with a single platform over time. Finally, the group is building a targeted NGP business focused on heated tobacco in Europe and vaping in selective markets, particularly the US. Investment is disciplined and based on detailed market testing. Overall, rather than trying in vain to out-compete its larger rivals, we believe Imperial is now operating within the confines of what is achievable for a number four player in a concentrated global market.

The group’s five-year plan is divided into two distinct periods. The two-year strengthening phase (2020-2022) built the foundation for the current three-year phase (2022-2025) which focuses on the acceleration of returns and sustainable growth in shareholder value. In this phase, the company expects to generate low single-digit net revenue growth and mid-single digit adjusted operating profit growth, defined as 3.5%-6.5%.

Performance in the financial year to September 2024 is expected to be weighted to the second half of the year, driven by the phasing of pricing in the prior year and investments in NGP.

In the six months to 31 March, revenue fell by 2.3% to £15.1bn, reflecting the decline in tobacco and NGP revenue due to adverse foreign exchange movements, partly offset by growth in Distribution revenue.

Tobacco net revenue grew by 2.3%, driven by strong pricing (+8.6%). Volumes fell by 6.3% (to 89.9bn sticks equivalent) reflecting wider industry market size declines across the group’s footprint. The group maintained its aggregate market share in its five priority markets, with three out of five markets growing – US (+5 bps), Spain (+50 bps), and Australia (+10 bps) – offsetting declines in Germany (-25 bps) and the UK (-40 bps). Volume was held back somewhat by disruption in the Middle East which affected shipment timings and results in the AAACE region.

NGP revenue rose by 16.8% as strong growth in Europe and AAACE more than offset declines in the US. In the past six months, the group has launched new products in all categories, including its entry into the US oral nicotine market with the new ‘zone’ brand.

Adjusted operating profit grew by 2.8% at constant currency to £1,699m, in line with guidance of low single-digit growth and driven by improved profitability in tobacco and NGP and growth in Distribution. NGP adjusted losses reduced by 9% to £50m as expected, with improved gross margin and volume growth supporting continued investment in new product launches. Distribution adjusted operating profit grew 18.2% reflecting good underlying growth due to tobacco price increases.

Adjusted EPS grew by 7.7% to 120.2p as reduced share count due to the ongoing share buyback more than offsetting higher finance costs and a higher tax rate.

The business typically generates strong cash flow which drives four pillars of capital allocation: investment in organic growth; strengthening the balance sheet; a progressive dividend; and share buybacks.

During the half-year to 31 March, adjusted operating cash conversion was 97%, reflecting working capital improvements. The group ended the period with net debt to £10.1bn, 3% above last year, and financial gearing of 2.5x net debt to EBITDA. The group remains on track to hit its 2.0x target by the year end. The all-in cost of debt only increased from 4.1% to 4.2%, while interest cover stands at a comfortable 8.9x. The group remains committed to its investment grade credit rating.

In line with its capital allocation policy and reflecting management’s confidence in the group’s strategy and cash generation, Imperial is currently buying back £1.1bn of shares in a programme that will run until September 2024, with £604m completed in the period. This represents just under 7% of the group’s share capital based on yesterday’s market closing share price and comes on top of last year’s £1.0bn buyback. This commitment forms part of an ongoing, multi-year buyback programme that will deliver a material reduction in the capital base over time. The company believes this is preferable to buying back some of its expensive debt even though the cost of servicing that debt is rising.

The dividend policy is to grow the payout annually, considering underlying business performance. This morning, the group has declared a half-year payment of 44.9p, up 4%. Taking dividends and the buyback together, Imperial expects capital returns to shareholders to exceed £2.4bn in the current fiscal year (c. 15% of its current market capitalisation) and £6bn over three years (37% of market cap).

Regulatory issues remain an overhang – we note the proposed UK tobacco control measures and levy on vapes – while a lack of market share improvement in Germany remains a concern.

Looking ahead, the group expects the continuing benefits of its transformation to enable a further acceleration in adjusted operating profit growth in the final two years of its five-year strategy. In FY2024, the group expects to deliver low-single-digit constant currency revenue growth and to grow its constant currency adjusted operating profit close to the middle of its mid-single digit range. In the second half, delivery will be underpinned by embedded tobacco pricing already taken in the first half and lower NGP losses.

Source: Bloomberg