Compass Group (CPG) is one of the largest and most entrenched food-service providers. Its extensive global footprint serves a diversified mix of sectors and geographies, providing the foundation for a narrow economic moat that generates consistent revenue streams and healthy cash flow. Combining this dynamic with an asset-light operating structure leads to strong returns on invested capital. Demand for Compass' services is moderately tied to both consumer and enterprise-level discretionary spending, which adds some cyclicality. Nevertheless, Compass appears well positioned to grow as enterprise-level outsourcing gains traction for the longer term.
The majority of Compass' revenue comes from the business and industry division, which manages corporate cafeterias. Typically provided as an employee perk, in-house food service also has the potential to boost overall productivity by reducing the time employees spend off campus. Employee food service is not an absolute necessity for most companies, but Compass has plenty of cost levers to pull when facing lagging sales or service cutbacks. This can be seen in slow but steady margin expansion during the most recent U.S. and European economic downturns.
In the longer term, food service remains a large fragmented global industry that offers Compass ample room to grow. The firm's global reach makes it one of the few vendors that can efficiently fulfil the needs of multinational companies with diverse locations. There is also opportunity to expand in the stable healthcare and education sectors, which maintain a high percentage of self-operated cafeterias. As costs continue to rise in these sectors, we expect more institutions will recognise the savings potential of outsourcing the food-service function.
Cross-selling support services such as cleaning and building maintenance will drive incremental revenue from customers in many sectors and geographies. Demand has softened recently in the energy, resource, and defence sectors. We believe emerging markets with economies tied to energy and commodity extraction typically require higher-margin remote and offshore services, and thus offer good longer-term growth opportunities.
Economic Moat: Competitive Advantage
Compass’ narrow moat comes from two primary sources: switching costs and cost advantage. Switching costs form a large part of Compass group’s narrow moat. Contracts in food service vary in length but are generally between three and five years. These multiyear contracts, combined with material fit-out costs, dissuade clients from switching providers, as does the potential disruption to service, particularly in sensitive areas such as hospital catering.
This is evidenced by contract retention rates averaging 94% over the past decade. Another reason for this high level of retention is strong relationship management. Compass establishes two points of contact with each client to ensure the highest level of communication exists.
For the most part, once a good working relationship has been established and pricing is competitive, clients generally have little motivation to switch providers, and hence opt to renew existing contracts. This is particularly true with clients that Compass services on a regional or global basis. As the firm is the largest of only three food-service companies with global capabilities, clients have little option but to choose Compass, unless they want the additional inconvenience of dealing with multiple operators across their networks.
