July 26 - Fitch Ratings has upgraded UK-based food services company Compass Group PLC's (Compass) Long-term Issuer Default Rating (IDR) and senior unsecured ratings to 'A-' from 'BBB+' and affirmed the Short-term IDR at 'F2'. The Outlook is Stable.
The upgrade reflects Compass's continued growth, strong balance sheet and consistent positive free cash flow generation over the past few years, as well as Fitch's expectation that the group will continue to expand through additional net new business wins and bolt-on acquisitions. The company's business profile benefits from a diversified customer base, strong customer retention rate (consistently above 90%), its contracted revenue base and high geographical diversification.
Compass has been increasing its presence in fast-growing emerging markets (17% of FY11 sales) in recent years. This has helped offset austerity-driven weakness in European markets that have caused a slight margin decline in recent periods. Fitch expects margins in Compass's Europe and Japan segment to remain under some pressure in the near term until cost-savings initiatives ramp up. The level of outsourcing in the foodservice industry remains low, notably in segments such as healthcare, education, sports and leisure (especially in Europe). Therefore, the group is expected to exhibit steady growth potential as a result of such structural change.
Fitch's analysis also includes a focus on the company's current cash deployment strategy. The company is expected to maintain adequate financial flexibility to complete infill acquisitions and shareholder return programmes while maintaining a financial profile consistent with an 'A-' rating.
Compass shows high free cash flow conversion, measured as pre-dividend FCF/total adjusted debt, consistently above 25%. This is higher than the median for a 'BBB+' rating (19%) and even 'A-' (23.6%) even though free cash flow as percentage of sales (between 1.9% to 3.2% in the past four years) is slightly weaker relative to the 'A-' median (mid-single digit). As Fitch expected, Compass resumed share repurchases in FY12 with a new GBP500m programme and is expected to complete much of the buybacks in the current fiscal year. In H112, Compass paid dividends of GBP243m and completed acquisitions totalling GBP188m. In its rating case projections, Fitch assumes about GBP550m between share buy backs and bolt-on acquisitions per annum until 2014.
Lease-adjusted gross debt/EBITDAR ratios increased modestly in FY11 (2.3x) due to the issuance of USD1bn of private placement notes to fund the maturity of notes and bonds due in May 2012. The company issued an additional EUR600m in February 2012. Lease-adjusted gross leverage is expected to decline to below 2.1x by year end 2012. However, FFO gross leverage is expected to remain stable between 2.5x-2.6x. As of March 2012, Compass had total debt of GBP2bn.
The group's most recently reported cash position is strong at GBP1.1 bn. However, the bond and note maturities in May 2012 are expected to bring cash closer to the historical average of GBP600m by the end of fiscal 2012. Compass's liquidity is further supported by an undrawn GBP700m five-year committed bank facility that matures in May 2017.
WHAT COULD TRIGGER A RATING ACTION?
Fitch is unlikely to upgrade the ratings further due to the low operating margin characteristics of the industry, modest free cash flow margins, and the asset-light nature of the business.
Negative: Future developments that may, individually or collectively, lead to negative rating action include: Negative organic sales growth and significant EBITDA margin erosion combined with FFO adjusted gross leverage remaining above 3.0x either as a result of operational weakness or a large debt-funded acquisition, along with FFO fixed charge cover below 4.5x and FCF/Total adjusted debt below 20%.