The FTSE 100 has a reputation for being steady, rather than spectacular, when it comes to investment returns. But Compass Group (LSE:CPG) might be an interesting exception.
Including the dividend, the stock has returned over 10% per year on average during what has been an unusually challenging last 10 years. I think it’s worth investors taking a closer look.
Contract catering
Compass Group provides catering services to places like hospitals, sports stadiums, and schools. In other words – places that would rather not be running their own food operations.
One obvious benefit to this type of business is that it’s not especially cyclical. Whatever’s going on with inflation or interest rates, people still need to eat.
While there’s competition in this industry, Compass also has an important advantage over other operators. Specifically, its scale puts it in a better negotiating position with suppliers.
Strong established relationships with customers committed to long-term contracts is another advantage. Importantly, I don’t think either of these is going to change any time soon.
Growth
Over the last 10 years, Compass has increased its revenues from around £17.4bn to just under £32bn. But earnings-per-share growth hasn’t been so spectacular – going from 54p to 62p.
There’s a big – and obvious – reason for this, which is the pandemic. People not going to offices or live events isn’t good for the firm that provides the catering.
As a result, Compass took on debt and issued shares to raise capital. And despite both of these coming down in the last few years, the effects are still visible in the firm’s income statement.
That’s why the stock looks expensive at a price-to-earnings (P/E) ratio of 45. But once debt and equity levels recover, the multiple should retreat to around 29, even without further growth.
Outlook
A P/E ratio of 29 is still high – especially by FTSE 100 standards – but I think Compass is an unusually strong business. And its growth prospects look particularly impressive.
The most obvious growth strategy involves winning new contracts. And with its size giving the company a cost advantage, it’s in a position to offer competitive prices to potential customers.
Acquisitions are also a key part of how Compass grows. Buying existing businesses helps the firm get a foothold in new markets and it can then use its scale advantages to expand.
This strategy can be risky – there’s a danger of overpaying for an acquisition that can’t be ignored. But it’s been very effective for the company so far and I expect it to continue.
Can the stock keep rising?
One of the big challenges Compass is facing at the moment is inflation. Both raw materials and staffing costs are rising and the company is going to have to find a way to work around this.
That being said, I don’t see obstacles for this type of business that come much bigger than the pandemic. This makes me think the next decade won’t be as difficult as the previous one.
As a result, I think Compass has a good chance of being one of the best FTSE 100 stocks over the next decade and believe investors who haven’t already taken a look should do so.
This post was originally published on Motley Fool
