Compass Group Regulatory News (CPG)

Legal Entity Identifier (LEI) No. 2138008M6MH9OZ6U2T68

Compass Group

Full year results announcement for the year ended 30 September 2019

1 Reconciliation of statutory to underlying results can be found on pages 39 to 40.

2 Prior year comparatives have been restated upon adoption of IFRS 15.

3 Measured on a constant currency basis.

4 Organic revenue growth.

Compass reports strong results with organic revenue growth of 6.4%,

driving earnings and dividend growth of 6%

Strong organic revenue growth of 6.4%, above target range of 4-6%

·; Excellent performance in North America with broad based organic revenue growth of 7.7%

·; Europe growth of 4.1% with strong performances in UK Defence and Sports & Leisure offsetting Business & Industry volume weakness

·; Rest of World growth of 4.3% driven by strong performances in Turkey, India and Spanish-speaking LATAM

Operating profit of £1.9 billion; up £84 million or 4.7% on constant currency basis

·; Operating margin was maintained at 7.4%

Strong balance sheet, earnings and dividend growth

·; Free cash flow increase of 9.3% to £1.2 billion resulting in net debt to EBITDA ratio of 1.3x

·; Full year dividend up 6.1% in line with constant currency earnings per share

Executing our strategy and focusing on our core food business

·; Continued to strengthen and simplify our portfolio. Completed several acquisitions and disposals for net cash cost of £377 million, and agreed the proposed acquisition of Fazer Food Services in the Nordics for €475 million

·; Good momentum behind our strategic priorities of Performance, People and Purpose

Positioning for the future

·; The outlook for the Group remains strong. We expect 2020 organic growth around the mid-point of our 4-6% guidance range whilst maintaining our strong margin

·; Against the backdrop of a deteriorating macro environment in Europe we are taking prompt action to adjust our cost base. These actions, which have also been extended to certain Rest of World markets, result in non-underlying cash charges of around £160 million over 2019 and 2020, and a non-cash charge of £140 million

Statutory results

·; Statutory operating profit decreased by 5.4% as a result of the impact of the cost action programme offset by higher profits and foreign exchange benefit. Statutory earnings per share decreased by 1.8%

Chief Executive's Statement 

Dominic Blakemore, Group Chief Executive, said:

"Compass has had another strong year. Organic revenue growth was 6.4%, ahead of our target range, thanks to excellent growth in North America and an improving performance in Rest of World. There was good growth in our European business with strong performances in UK Defence and Sports & Leisure offsetting weak volumes in Business & Industry. The Group margin during 2019 was maintained despite this more challenging trading environment in Europe.

We are making good strategic progress through disciplined focus on our Performance, People and Purpose priorities and have continued to reshape our portfolio. Disposal proceeds have been reinvested in bolt-on acquisitions to further strengthen our food service offer and subsector approach, and in June we announced the proposed acquisition of Fazer Food Services, a leading food service business in the Nordics, which is a strong strategic fit with Compass.

Despite this good performance, we are not immune to the macro environment. Deteriorating business and consumer confidence in Europe has impacted our Business & Industry volumes, new business activity and margin. Given these trends, we are taking prompt action in Europe and certain Rest of World markets to adjust our cost base. As well as offsetting short-term margin pressures, by taking this action from a position of strength, we will be better placed to capitalise on future growth opportunities.

Our expectations for the Group in 2020 are positive although we remain cautious on the macro environment in Europe. The pipeline of new contracts in North America is strong and Rest of World is growing well, although we are seeing some hesitation in decision making in Europe. Thanks to the Group's geographic and sectoral diversity, we are nevertheless confident of continued progress. As such we expect organic growth to be around the mid-point of our 4-6% range whilst maintaining our strong margin1 as we mitigate the expected volume pressures through our cost actions.

In the longer term, we remain excited about the significant structural growth opportunities globally, the potential for further revenue and profit growth, combined with further returns to shareholders." 

Results presentation today

The results presentation for investors and analysts is being held today, Tuesday 26 November 2019, at 9.00 a.m. A live webcast of the results presentation will be broadcast today at 9.00 a.m., accessible via the Company's website, www.compass-group.com. At the end of the presentation you will be able to participate in a question and answer session by dialling:

Financial calendar

Enquiries

1 Pre IFRS 16 'Leases'. IFRS 16 will be adopted by the Group on 1 October 2019. 

Chief Executive's Statement (continued)

Basis of preparation

Throughout this preliminary results announcement, and consistent with prior years, underlying and other alternative performance measures are used to describe the Group's performance. These are not recognised under International Financial Reporting Standards (IFRS) or other generally accepted accounting principles (GAAP).

The Executive Committee of the Group manages and assesses the performance of the business on these measures and believes they are more representative of ongoing trading, facilitate meaningful year on year comparisons, and hence provide more useful information to shareholders. Underlying measures are defined in the glossary of terms on pages 43 and 44.

A summary of the adjustments from statutory results to underlying results is shown in note 10 on pages 39 and 40 and further detailed in the consolidated income statement (page 22), reconciliation of free cash flow (page 28), note 3 segmental reporting (page 34) and note 11 organic revenue and organic profit (page 41).

Group overview

Revenue for the Group grew by 6.4% on an organic basis, as we continue to expand within the £200 billion global food services market. New business wins were 7.9% driven by strong MAP 1 (client sales and marketing) performance in all regions. Our retention rate was maintained at 94.8% as a result of our ongoing focus and investment in service and quality. Like for like revenue grew by 3.7% reflecting sensible price increases and strong volume growth in Sports & Leisure, partially offset by weak Business & Industry volumes in Europe. On a statutory basis, revenue increased by 8.8%, including the positive impact from foreign currency translation.

Underlying operating profit increased by 4.7% (£84 million) on a constant currency basis. Operating profit margin remained at 7.4% despite the more challenging trading environment in Europe. We continue to work hard to drive efficiencies across the business to offset cost pressures including the higher mobilisation costs from increased new business wins. We have maintained our focus on MAP 3 (cost of food) with ongoing initiatives such as supplier and product rationalisation, improved menu planning and food waste reduction programmes.

Optimising MAP 4 (labour and in unit costs) and MAP 5 (above unit overheads) with initiatives around better labour scheduling, workforce management, work design, training and retention have become ever more important, particularly in markets such as Europe and the USA where labour inflation persists. On a statutory basis, operating profit decreased by 5.4% as the impact of cost action charges offset higher profits and benefits of foreign exchange.

As a result of the business' continued strong earnings growth and cash flow generation, we propose an annual dividend of 40.0 pence per share, up 6.1% on the prior year.

Taking appropriate cost actions

We are seeing good performances across most of the Group, however we are not immune to macroeconomic challenges. Although our European business is in good shape, delivering organic revenue growth of 4.1%, as previously indicated we have been seeing pressures in the region, particularly in some of our largest markets. These pressures have been increasing during the year, impacting volumes in our Business & Industry sector, and consequently are having a significant impact on our European margin. Consumer confidence continues to decline and a number of key clients, notably in manufacturing, automotive and financial services, have reduced their headcount in recent months.

Given this trading backdrop, we are taking prompt action to ensure we have the right sized labour model for the future. This will protect the profitability of the business and further strengthen our strong operational position, enabling us to continue to capitalise on the attractive growth opportunities we see in Europe. Although the vast majority of these actions are focused on Europe, they have also been extended to a limited number of countries in Rest of World. 

These cost actions will result in a total non-underlying charge for the Group of around £300 million, of which £190 million has been incurred in FY19, with the remainder expected to be incurred in FY20. Approximately £160 million of the total charge is cash, with £29 million having been spent in FY19. This mostly relates to removing some MAP 4 (in unit labour) and some MAP 5 (overhead) costs, and has around a two year payback. The FY19 charge also includes a one-off non-cash charge of £120 million in respect of a change in the expected profitability of some of those contracts that have been affected by the recent deterioration in business and consumer confidence and that are now considered to be structurally loss making and where asset impairments have been taken. The run-rate for annual savings resulting from the cost actions is expected to be c. £90 million as we exit this year and have already been factored into the 2020 guidance.

Chief Executive's Statement (continued)

Regional performances

North America - 62.4% Group revenue (20181: 59.3%)

1 Prior year comparatives have been restated upon adoption of IFRS 15.

Our North American business, which now accounts for over 60% of Group revenue, delivered an excellent performance, with organic revenue growth of 7.7%. Growth was driven by good levels of new business and a strong retention rate across all sectors. As in previous years, around 40% of new business was from first time outsourcing, underlining the strong structural growth opportunities within our largest market. Like for like revenue growth benefited from pricing and positive trading volumes from our Sports & Leisure sector.

Strong growth in our Business & Industry sector was driven by continued good net new business and some like for like growth. New contract wins include the Canadian Imperial Bank of Commerce, American Airlines headquarters and Humana Inc.

Solid organic revenue growth in our Healthcare & Seniors sector reflected good levels of new business. New contract wins include the Atrium Health and Lexington Health Network, as well as significant additional business with Tenet Healthcare.

Our Education sector reported strong net new business including contract wins with New York University, Butler University and the Florence County Schools District.

Our Sports & Leisure sector delivered a good organic performance with an excellent retention rate and like for like volume growth. Contract wins include Allegiant Stadium, home to the Las Vegas Raiders, and the Lexington Convention Center.

Underlying operating profit of £1,290 million increased by 9.0% (£106 million) on a constant currency basis. Ongoing efficiency initiatives resulted in modest underlying margin progression for the year.

Chief Executive's Statement (continued)

Europe - 23.3% Group revenue (20181: 24.9%)

1 Prior year comparatives have been restated upon adoption of IFRS 15.

Organic revenue growth in Europe was 4.1% for the full year, although growth slowed in the second half. This included strong growth from new business, notably the UK Defence contracts in the first half and Puy du Fou in France in the fourth quarter, in addition to strong trading in the Sports & Leisure sector. This was partially offset by lower volumes in Business & Industry across key markets where we have seen reduced participation and lower consumer spend. 

Our new contract wins during the period include Landsec in the UK, Cercle National des Armées in Paris and Hôpitaux Robert Schuman in Luxembourg. Contract extensions include Chelsea Football Club in the UK.

Underlying operating profit declined on a constant currency basis by £26 million or 6.6%. The region delivered a good level of organic revenue growth overall, supported by a strong performance in Sports & Leisure, where increased revenues tend to have a lower drop through to profit. Our focus on efficiencies, pricing and portfolio management has only partially offset the weakness in Business & Industry volumes (which declined significantly in the fourth quarter), cost inflation, and the higher mobilisation costs (associated with the strong growth). In aggregate, the underlying operating margin declined by 60 basis points to 6.3%.

Chief Executive's Statement (continued)

Rest of World - 14.3% Group revenue (20181: 15.8%)

1 Prior year comparatives have been restated upon adoption of IFRS 15.

Organic revenue in our Rest of World region grew by 4.3%, including a strong performance in Turkey, India, Spanish speaking LATAM and our Offshore & Remote business outside Australia, notably Kazakhstan.

The Business & Industry and Education sectors of the region continue to perform well and experienced good growth. New business wins include Bloomberg in Hong Kong, Mercedes Benz in Brazil and Bursa City Hospital in Turkey. We continue to retain contracts including Victoria Zoos in Australia, Mondelez in Argentina and Amazon in India.

As expected, our Offshore & Remote business returned to growth in the second half of the year as we lapped the large Australian construction project that moved to production towards the end of 2018. Across the region we have continued to win and retain contracts.

Underlying operating profit improved by 5.9% (£16 million) on a constant currency basis, with the underlying operating margin improving in part due to portfolio management and implementation of pricing, purchasing and productivity initiatives. We remain focused on best practice sharing and driving efficiencies across the business.

Chief Executive's Statement (continued)

Group strategy

Our refreshed strategy, announced 18 months ago, ensures that we further improve the long term quality and sustainability of our financial results.

We remain focused on food, our core competency. The global food services market is estimated to be more than £200 billion. We see a large and exciting structural growth opportunity, with only about 50% of the market currently outsourced, of which approximately one third is in the hands of small and regional players. We have a good track record in winning first time outsourcing contracts.

The large and disparate nature of the food services market makes it challenging to offer clients a one size fits all solution. Therefore, we segment the market into various sectors and subsectors using our portfolio of B2B brands. This allows us to get close to our clients, understand their needs and create different and exciting offers that meet their requirements and differentiate us from the competition.

We are the largest player in the global market. As we continue to grow and increase our scale, we further extend our competitive advantage and our position as the most efficient provider. This allows us to offer our clients and consumers the most exciting and innovative solutions, as well as the best value. The ability to innovate is important to ensure we meet our clients' and consumers' rapidly evolving tastes and needs, and our decentralised structure means we are well placed to pilot concepts in local markets before expanding across the Group where appropriate.

By stepping up the intensity with which we manage the business and with a disciplined focus on Performance, People and Purpose as our main strategic priorities, we are well placed to continue to create sustainable long term value for all of our stakeholders.

Performance

Portfolio

To continue to drive our performance we are actively managing our portfolio of businesses. Targeted and disciplined bolt-on acquisitions are an effective way to strengthen our capabilities, broaden our offering and increase our scale. M&A has also proven to be an extraordinary source of talent. During 2019 we invested £478 million, principally in North America. There remains a good pipeline of bolt-on opportunities across the Group.

We have continued to make progress on our disposal programme and during the year completed several disposals that bring cumulative revenues now disposed or exited to c. 3% of Group revenue at an average margin of c. 4%. As previously indicated, the overall programme of up to £1.2 billion revenues is expected to be margin neutral. The programme will complete during 2020.

MAP culture

For over 10 years, we have used our Management and Performance (MAP) framework to drive performance across the business. It is a simple framework that we all use to help us focus on a common set of business drivers, whether it is winning new business in the right sectors with the right terms (MAP 1), increasing our consumer participation and spend (MAP 2), reducing our food costs (MAP 3), our labour costs (MAP 4) or our overheads (MAP 5).

Under the refreshed strategy we are codifying best practices and developing tools and templates to help us execute with more intensity and consistency across the Group. Our areas of focus are pricing, purchasing and productivity. We have begun with our larger markets and are rolling out initiatives depending on the maturity of their functions. We will continue to use MAP to ensure we have a disciplined focus on execution.

These initiatives are often supported through technology and digital capability - both in terms of driving efficiencies and optimising performance and also in developing products and services which improve the consumer experience. Our digital strategy is implemented locally in the most cost effective and relevant way for each market. We are making investment into systems and processes that will ultimately unlock more efficiencies and leverage scale across the business in the long term.

Chief Executive's Statement (continued)

People

People are our biggest source of competitive advantage. They are the key to delivering excellent food service to our clients and consumers together with strong financial results. We are in the process of further enhancing our employee proposition to ensure we have an engaged, high performing, and fulfilled workforce that truly reflects the diversity of the societies we live in and the communities we serve.

Our objective is to create an exceptional people business that is inclusive, engaged and committed to developing our people and providing them with the safest and fairest environment in which to work. We are launching initiatives and improving our processes to ensure we can:

·; attract and develop the best leaders,

·; recruit, retain and develop the highest quality unit managers in the industry,

·; have the best and most inclusive work places in the world with a fully engaged workforce, and

·; have a diverse workforce that mirrors the communities in which we operate.

For example, in May we launched our unit manager development programme and to date around 2,000 unit managers have participated in the tailored offsite programme. We also launched the Compass Commitments of Respect, Growth and Teamwork - what people can expect when they are part of our business. In October, we conducted a global engagement survey to help us to identify areas where we need to take action to ensure people are experiencing our Commitments.

Purpose

Our purpose is first and foremost a social purpose, the foundation of which is a safety culture built around caring for our people and our consumers - delivering personal and food safety. We are integrating our sustainability strategy into the business focused on:

·; increasing the role of health and wellbeing in our value proposition

·; taking targeted actions where we can make the greatest environmental difference, and

·; driving positive outcomes beyond our business to make the world a better place, such as our continued work with our suppliers to source products responsibly and our commitment to enrich local communities.

We already have a strong commitment to corporate responsibility. We are now building on this existing strength and working more proactively with our clients and consumers in those areas. For example, this year's Stop Food Waste Day, which Compass USA founded in 2017, extended across 38 countries with awareness about the campaign reaching 89 million people on social media.

Cash, Balance Sheet and Returns To Shareholders

Excellent cash flow generation, a strong balance sheet and returns to shareholders continue to be an integral part of our business model. Our priorities for how we use our cash remain unchanged. We will continue to: (i) invest in the business to support organic growth where we see opportunities with good returns; (ii) grow the dividend in line with underlying constant currency earnings per share; (iii) pursue M&A opportunities; our preference is for small to medium sized bolt-on acquisitions, where we look for returns greater than the cost of capital by the end of year two; (iv) maintain strong investment grade credit ratings by returning any surplus cash to shareholders to target net debt to EBITDA of around 1.5x1. 

1 Pre IFRS 16 'Leases'. IFRS 16 will be adopted by the Group on 1 October 2019. The Group expects between £950 - £1,050 million of additional debt on its balance sheet on adoption. 

Chief Executive's Statement (continued)

Summary and outlook

Compass has had another strong year. Organic revenue growth was 6.4%, ahead of our target range, thanks to excellent growth in North America and an improving performance in Rest of World. There was good growth in our European business with strong performances in UK Defence and Sports & Leisure offsetting weak volumes in Business & Industry. The Group margin during 2019 was maintained despite this more challenging trading environment in Europe.

We are making good strategic progress through disciplined focus on our Performance, People and Purpose priorities and have continued to reshape our portfolio. Disposal proceeds have been reinvested in bolt-on acquisitions to further strengthen our food service offer and subsector approach, and in June we announced the proposed acquisition of Fazer Food Services, a leading food service business in the Nordics, which is a strong strategic fit with Compass.

Despite this good performance, we are not immune to the macro environment. Deteriorating business and consumer confidence in Europe has impacted our Business & Industry volumes, new business activity and margin. Given these trends, we are taking prompt action in Europe and certain Rest of World markets to adjust our cost base. As well as offsetting short-term margin pressures, by taking this action from a position of strength, we will be better placed to capitalise on future growth opportunities.

Our expectations for the Group in 2020 are positive although we remain cautious on the macro environment in Europe. The pipeline of new contracts in North America is strong and Rest of World is growing well, although we are seeing some hesitation in decision making in Europe. Thanks to the Group's geographic and sectoral diversity, we are nevertheless confident of continued progress. As such we expect organic growth to be around the mid-point of our 4-6% range whilst maintaining our strong margin1 as we mitigate the expected volume pressures through our cost actions.

In the longer term, we remain excited about the significant structural growth opportunities globally, the potential for further revenue and profit growth, combined with further returns to shareholders.

Dominic Blakemore

Group Chief Executive Officer

26 November 2019

1 Pre IFRS 16 'Leases'. IFRS 16 will be adopted by the Group on 1 October 2019.

Business Review

2019 has been another strong year with organic revenue growth of 6.4%, underlying margin of 7.4% and an increase in underlying free cash flow of 9.3%.

Definitions of underlying measures of performance can be found in the glossary on pages 43 and 44.

Business Review (continued)

Segmental performance

Statutory and underlying results

1 Definitions of underlying measures of performance can be found in the glossary on pages 43 and 44.

2 Reconciliation between the different growth rates is provided in note 11.

3 Prior year comparatives have been restated upon adoption of IFRS 15.

Further details of the adjustments can be found in the consolidated income statement, note 3 segmental reporting and note 10 statutory and underlying results. 

Business Review (continued)

Adoption of new accounting standards

The Group has applied the new accounting standards IFRS 15 'Revenue from contracts with customers' and IFRS 9 'Financial instruments' in the current year. Comparatives for 2018 have been restated to reflect the impact of IFRS 15, resulting in a net increase in operating profit and decrease in revenue of less than 1%. The adoption of IFRS 9 has not had a material impact and the Group has adjusted opening retained earnings to reflect an additional provision for impairment of trade receivables using the expected credit loss model.

The Group will adopt IFRS 16 'Leases' from 1 October 2019. The Group's estimate of the financial impact of these changes on the consolidated balance sheet is the recognition of an additional lease liability between £950 million and £1,050 million. Under our chosen transition option, the results for the 2019 financial year will not be restated. The net impact of IFRS 16 on the consolidated income statement is expected to be immaterial.

Statutory results

Revenue

On a statutory basis, revenue was £24,878 million (20181: £22,872 million), representing growth of 8.8%, mainly driven by organic growth and partially by foreign exchange benefits.

Operating profit

Operating profit was £1,601 million (20181: £1,693 million), a decrease of 5.4% over the prior year as the impact of the cost action programme offset higher profits and foreign exchange benefits.

Statutory operating profit includes non-underlying items of £281 million (2018: £51 million). The most significant non-underlying items are explained further below; for a full list refer to note 10.

Deteriorating business and consumer confidence in Europe has impacted our Business & Industry volumes, new business activity and margin. Given these trends, we are taking prompt action in Europe and certain Rest of World markets to adjust our cost base. As a result, the Group's income statement includes a cost action programme charge of £190 million. Included within this amount, there is a one-off non-cash charge of £120 million in respect of a change in the expected profitability of some of those contracts that have been affected by the recent deterioration in business and consumer confidence and that are now considered to be structurally loss making and where asset impairments have been taken. Of the £190 million non-underlying charges, £29 million has been paid in the year to 30 September 2019.

Net loss on sale and closure of businesses

As a result of the strategic review of the business, the Group is in the process of selling or exiting its operations in a number of countries, sectors or businesses in order to simplify its portfolio. The Group has successfully completed the sale of several businesses, including its operations in South Africa, Vision Security Group in the UK, Sports & Leisure in Japan and part of its US laundries business. As a result, the Group has recognised a net gain of £50 million on the sale and closure of businesses (2018: £3 million loss), including price adjustments to disposals completed in prior years. This gain was offset by £57 million exit costs and asset write downs relating to committed or completed business exits (2018: £55 million).

As at the balance sheet date, the Group has further classified certain businesses as held for sale as these disposals are highly probable and expected to be completed within 12 months.

Finance costs

Net finance costs increased to £125 million (2018: £112 million), mainly due to the change in fair value of certain derivatives.

Tax charge

Profit before tax was £1,469 million (20181: £1,523 million) giving rise to an income tax expense of £351 million (20181: £385 million), equivalent to an effective tax rate of 23.9% (20181: 25.3%).

Earnings per share

Basic earnings per share were 70.0 pence (20181: 71.3 pence), a decrease of 1.8% as the impact of the cost action programme offset higher profits and foreign exchange benefits.

1 Prior year comparatives have been restated upon adoption of IFRS 15. 

Business Review (continued)

Underlying results

We track our performance against underlying and other alternative performance measures, which we believe best reflect our strategic priorities of growth, efficiency and shareholder returns.

A summary of adjustments from statutory results to underlying results is shown in note 10 on pages 39 and 40 and further detailed in the consolidated income statement (page 22), reconciliation of free cash flow (page 28), note 3 segmental reporting (page 34) and note 11 organic revenue and organic profit (page 41).

Revenue

On an organic basis, revenue increased by 6.4%. New business wins were 7.9%, driven by strong performance across the regions. Our retention rate was 94.8% as a result of our ongoing focus and investment in service and quality. Like for like revenue growth was 3.7%, reflecting sensible price increases and strong volume growth in Sports & Leisure, partially offset by weak Business & Industry volumes in Europe.

Operating profit

Underlying operating profit was £1,882 million (20181: £1,744 million), an increase of 7.9%. If we restate 2018's profit at the 2019 average exchange rates, it would increase by £54 million to £1,798 million. On a constant currency basis, underlying operating profit has therefore increased by £84 million, or 4.7%.

Operating margin

With very strong revenue growth the operating profit margin remained unchanged from the prior year at 7.4% as we continue to work hard to drive efficiencies across the business through our MAP framework.

Finance costs

The underlying net finance cost was £110 million (2018: £114 million). For 2020, we expect an underlying net finance cost of around £110 million.

Tax charge

On an underlying basis, the tax charge was £413 million (20181: £388 million), equivalent to an effective tax rate of 23.3% (20181: 23.8%). The rate reduction primarily reflects the full year impact of the reduction in the US federal tax rate introduced by the Tax Cuts and Jobs Act, whilst the prior year comparative only includes nine months of benefit. The tax environment continues to be very uncertain, with more challenging tax authority positions and investigations globally. Our current expectations are that the 2020 effective tax rate will increase to around 24%.

Earnings per share

On a constant currency basis, the underlying basic earnings per share increased by 6.0% to 85.2 pence (20181: 80.4 pence).

Shareholder returns

Dividends

Our dividend policy is to grow the dividend in line with growth in underlying constant currency earnings per share.

In determining the level of dividend in any year in accordance with the policy, the Board also considers a number of other factors that influence the proposed dividend, which include but are not limited to:

·; the level of available distributable reserves in the Parent Company

·; future cash commitments and investment needs to sustain the long term growth prospects of the business

·; potential strategic opportunities

·; the level of dividend cover

Further surpluses, after considering the matters set out above, are distributed to shareholders over time by way of special dividend payments, share repurchases or a combination of both.

1 Prior year comparatives have been restated upon adoption of IFRS 15. 

Business Review (continued)

Compass Group PLC, the Parent Company of the Group, is a non-trading investment holding company which derives its distributable reserves from dividends paid by subsidiary companies. The level of distributable reserves in the Parent Company is reviewed annually and the Group aims to maintain distributable reserves that provide adequate cover for dividend payments. The distributable reserves of the Parent Company include the balance on the profit and loss account reserve, which at 30 September 2019 amounted to £1,252 million.

The Group is currently in a strong position to continue to fund its dividend, which continues to be well covered by cash generated by the business. Details of the Group's going concern assessment can be found on page 17.

The ability of the Board to maintain its future dividend policy will be influenced by a number of the principal risks identified on pages 18 to 21 that could adversely impact the performance of the Group, although we believe we have the ability to mitigate those risks as outlined on pages 19 to 21.

It is proposed that a final dividend of 26.9 pence per share be paid on 24 February 2020 to shareholders on the register on 17 January 2020. This will result in a total dividend for the year of 40.0 pence per share (2018: 37.7 pence per share), a year on year increase of 6.1%. The dividend is covered 2.1 times on an underlying earnings basis and 2.0 times on a cash basis.

The final dividend of 26.9 pence will be paid gross and a Dividend Reinvestment Plan (DRIP) will be available. The last date for receipt of elections for the DRIP will be 3 February 2020.

Share buyback programme

The Group did not buy any shares during the period under the share buyback programme (2018: £nil). The directors' authority to purchase the Company's shares in the market was renewed by the shareholders at the Company's Annual General Meeting held on 7 February 2019.

Share price

The market price of the Group's ordinary shares at the close of the financial year was 2,093.00 pence per share (2018: 1,706.00 pence per share).

Underlying free cash flow

Underlying free cash flow totalled £1,247 million (2018: £1,141 million), an increase of 9.3%, which includes the benefit of approximately 3.8% from currency translation. Underlying free cash flow conversion was 66% (20181: 65%).

Gross capital expenditure of £853 million (2018: £813 million) is equivalent to 3.4% (20181: 3.5%) of underlying revenues. We continue to deliver strong returns on our capital expenditure across all regions. In 2020, we expect capital expenditure to be up to 3.5% of revenue.

The working capital inflow, excluding provisions and pensions, was £59 million (20181: £126 million inflow). This inflow was better than expected due to favourable timing.

The outflow related to post employment benefit obligations net of service costs was £15 million (2018: £8 million). Following the completion of the triennial valuation of the Compass Group Pension Plan (UK), which continues to have a funding surplus, we expect a total outflow for the Group of around £20 million in 2020.

The net interest outflow was £107 million (2018: £95 million).

The underlying cash tax rate was 19% (20181: 20%).

Acquisitions

The total cash spent on acquisitions in the year, net of cash acquired, was £478 million (2018: £452 million), comprising £449 million of bolt-on acquisitions and investments in associates, £33 million of contingent consideration relating to prior years' acquisitions offset by £4 million of cash acquired net of acquisition transaction costs.

The Group made several bolt-on acquisitions during the year, including the purchase of Client Rewards for an initial consideration of £164 million ($209 million). Client Rewards is an Iowa based company, that provides procurement and supply chain management services.

1 Prior year comparatives have been restated upon adoption of IFRS 15. 

Business Review (continued)

Disposals

As a result of the strategic review of the business, the Group is in the process of selling or exiting its operations in a number of countries, sectors or businesses in order to simplify its portfolio. The Group has successfully completed the sale of several businesses, including its operations in South Africa, Vision Security Group in the UK, Sports & Leisure in Japan and part of its US laundries business. As at the balance sheet date, the Group has further classified certain businesses as held for sale as these disposals are highly probable and are expected to be completed within 12 months.

The Group received £101 million (2018: £39 million) in respect of disposal proceeds net of exit costs.

Financial position

Net debt

The ratio of net debt to market capitalisation of £33,273 million as at 30 September 2019 was 9.8% (2018: 12.5%).

Net debt decreased slightly to £3,272 million (2018: £3,383 million). The ratio of net debt to EBITDA was 1.3x. This is lower than our target as we are waiting for EU competition clearance for the proposed acquisition of Fazer Food Services. Our leverage policy is to maintain strong investment grade credit ratings, returning any surplus cash to shareholders to target net debt to EBITDA of around 1.5x2.

The Group generated £1,247 million of underlying free cash flow (2018: £1,141 million), including investing £806 million in net capital expenditure, and spent £377 million on acquisitions net of disposal proceeds. £403 million was paid in respect of the final dividend for the financial year 2018 and £208 million was paid for the interim 2019 dividend.

The remaining £148 million movement in net debt related predominantly to foreign currency translation and other non-cash movements.

Return on capital employed

Return on capital employed was 19.5% (20181: 20.2%) based on net underlying operating profit after tax at the underlying effective tax rate of 23.3% (20181: 23.8%). This decrease reflects the short term impact of the recent acquisition activity of the Group. The average capital employed was £7,380 million (20181: £6,539 million).

Post employment benefit obligations

The Group has continued to review and monitor its pension obligations throughout the period, working closely with the trustees and members of all schemes around the Group to ensure proper and prudent assumptions are used and adequate provisions and contributions are made.

During the year we completed the triennial actuarial valuation for the Compass Group Pension Plan (UK). This valuation showed a net surplus of £142 million on the scheme's funding basis. As a result, there is no requirement to agree a recovery plan with the trustees.

The Lloyds Banking Group's High Court hearing on Guaranteed Minimum Pension (GMP) equalisation was published on 26 October 2018. As a result, and based on actuarial advice, the Group has recognised £12 million of pre-tax past service costs in the consolidated income statement. This non-cash charge has been excluded from the Group's underlying operating profit.

The Compass Group Pension Plan (UK) surplus of £448 million (2018: £346 million) and the £259 million (2018: £224 million) deficit in the rest of the Group's defined benefit pension schemes reflect the results of the triennial valuation of the UK plan and the actuarial gains and losses that have occurred since the prior year IAS 19 actuarial valuation.

The total pensions charge for defined benefit contribution schemes in the year was £126 million (2018: £110 million) and £33 million (2018: £24 million) for defined benefit schemes.

1 Prior year comparatives have been restated upon adoption of IFRS 15.

2 Pre IFRS 16 'Leases'. IFRS 16 will be adopted by the Group on 1 October 2019. The Group expects between £950 - £1,050 million of additional debt on its balance sheet on adoption. 

Business Review (continued)

Financial management

The Group manages its liquidity, foreign currency exposure and interest rate in accordance with the policies set out below.

The Group's financial instruments comprise cash, borrowings, receivables and payables that are used to finance the Group's operations. The Group also uses derivatives, principally interest rate swaps, forward currency contracts and cross currency swaps, to manage interest rate and currency risks arising from the Group's operations. The Group does not trade in financial instruments. The Group's treasury policies are designed to mitigate the impact of fluctuations in interest rates and exchange rates and to manage the Group's financial risks. The Board approves any changes to the policies.

Liquidity risk

The Group finances its operations through cash generated by the business and borrowings from a number of sources including the bank, the public and the private placement markets. The Group has developed long term relationships with a number of financial counterparties with the balance sheet strength and credit quality to provide credit facilities as required. The Group seeks to avoid a concentration of debt maturities in any one period to spread its refinancing risk.

In August 2019 the Group completed the refinancing of its Syndicated Revolving Credit Facility (SRCF). The new £2 billion SRCF matures in August 2024 and replaces the £1 billion SRCF and £690 million bilateral loans due to mature in June 2021 and December 2020 respectively. The new SRCF contains no financial covenants.

The maturity profile of the Group's principal borrowings at 30 September 2019 shows that the average period to maturity is 5.4 years (2018: 5.4 years). The Group's undrawn committed bank facilities at 30 September 2019 were £2,000 million (2018: £1,690 million).

Foreign currency risk

The Group's policy is to balance its principal projected cash flows by currency to actual or effective borrowings in the same currency. As currency cash flows are generated, they are used to service and repay debt in the same currency. Where necessary, to implement this policy, forward currency contracts and cross currency swaps are taken out which, when applied to the actual currency borrowings, convert these to the required currency.

The borrowings in each currency can give rise to foreign exchange differences on translation into sterling. Where the borrowings are either less than, or equate to, the net investment in overseas operations, these exchange rate movements are treated as movements on reserves and recorded in the consolidated statement of comprehensive income rather than in the consolidated income statement.

Non-sterling earnings streams are translated at the average rate of exchange for the year. Fluctuations in exchange rates have given, and will continue to give, rise to translation differences. The Group is only partially protected from the impact of such differences through the matching of cash flows to currency borrowings.

Interest rate risk

As set out above, the Group has effective borrowings in a number of currencies and its policy is to ensure that, in the short term, it is not materially exposed to fluctuations in interest rates in its principal currencies. The Group implements this policy either by borrowing fixed rate debt or by using interest rate swaps so that the interest rates on at least 80% of the Group's projected debt are fixed for one year. For the second and third year, interest rates are fixed within ranges of 30%-70% and 0%-40% respectively.

Group tax policy

As a Group, we are committed to creating long term shareholder value through the responsible, sustainable and efficient delivery of our key business objectives. This will enable us to grow the business and make significant investments in the Group and its operations.

We therefore adopt an approach to tax that supports this strategy and also balances the various interests of our stakeholders including shareholders, governments, employees and the communities in which we operate. Our aim is to pursue a principled and sustainable tax strategy that has strong commercial merit and is aligned with our business strategy. We believe this will enhance shareholder value whilst protecting Compass' reputation.

Business Review (continued)

In doing so, we act in compliance with the relevant local and international laws and disclosure requirements, and we conduct an open and transparent relationship with the relevant tax authorities that fully complies with the Group's Code of Business Conduct and Code of Ethics.

In an increasingly complex international corporate tax environment, a degree of tax risk and uncertainty is, however, inevitable. Tax risk can arise from differences in interpretation of regulations, but most significantly where governments apply diverging standards in assessing intragroup cross border transactions. This is the situation for many multinational organisations. We manage and control these risks in a proactive manner and, in doing so, exercise our judgement and seek appropriate advice from relevant professional firms. Tax risks are assessed as part of the Group's formal governance process and are reviewed by the Board and the Audit Committee on a regular basis.

Risks and uncertainties

The Board takes a proactive approach to risk management with the aim of protecting its employees and customers and safeguarding the interests of the Group, its shareholders, employees, clients, consumers and all other stakeholders.

The principal risks and uncertainties that face the business and the activities the Group undertakes to mitigate these are set out on pages 18 to 21.

Related party transactions

Details of transactions with related parties are set out in note 31 of the consolidated financial statements. These transactions have not had, and are not expected to have, a material effect on the financial performance or position of the Group.

Going concern

The Group's business activities, together with the factors likely to affect its future development, performance and position are set out in the Business Review, as is the financial position of the Group, its cash flows, liquidity position, and borrowing facilities.

The Group has considerable financial resources together with longer term contracts with a number of clients and suppliers across different geographic areas and industries. As a consequence, the directors believe that the Group is well placed to manage its business risks successfully.

After making enquiries, the directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the 12 months from the date of approval of the Annual Report. For this reason, they continue to adopt the going concern basis in preparing the financial statements.

Karen Witts

Group Chief Financial Officer 

26 November 2019 

Risk Management

Identifying and managing risk

The Board continues to take a proactive approach to recognising, assessing and mitigating risk with the aim of protecting its employees and consumers and safeguarding the interests of the Company and its shareholders.

Risk management is an essential element of business governance and, as set out in the Corporate Governance section in the Annual Report, the Group has policies and procedures in place to ensure that risks are properly identified, evaluated and managed at the appropriate level within the business. The identification of risks and opportunities, the development of action plans to manage the risks and maximise the opportunities, and the continual monitoring of progress against agreed key performance indicators (KPIs) are integral parts of the business process and core activities throughout the Group.

Risk Governance Framework

The Group runs a formal risk management process as part of which the Group's Principal Risks (highlighted on pages 19 to 21) are assessed and prioritised, with the Board having overall responsibility for risk management.

Risks are reviewed by country and regional leadership teams on an ongoing basis and are assessed to identify and document corresponding mitigating actions. Risk updates form an integral part of periodic management reviews and are also reviewed by other members of the Group's senior leadership and the Group's Risk and Governance Committees. Additional reviews are performed by Group Internal Audit. This bottom up and top down approach provides awareness and agreement on key risks facing the Group. The Board reviews a Major Risk Assessment report, including principal risks and areas of emerging risks, which is formally reviewed twice a year.

Our Principal Risks

The tables on pages 19 to 21 set out the principal risks and uncertainties facing the business at the date of this Announcement and any changes to the status of the risks since 2018. These have been subject to robust assessment and review. They do not comprise all of the risks that the Group may face and are not listed in any order of priority. Additional risks and uncertainties not presently known to management or deemed to be less material at the date of this Report, may also have an adverse effect on the Group. As a global business operating in countries and regions with diverse economic and political conditions, the Group's operations and earnings may be adversely affected by political or economic instability, including instability caused by the implementation of the UK's decision to exit the European Union (EU) (Brexit).

There is still significant uncertainty about the potential withdrawal from the EU, the timeframe, the outcome of negotiations about future arrangements between the UK and the EU, and the period for which existing EU laws for member states continue to apply to the UK. The Board views the potential impact of Brexit as an integral part of its principal risks rather than as a stand-alone risk.

We have identified a potential impact on our food supply chain in the UK relating to Brexit through potential increased import costs from weaker sterling, compounded by potential new import duties and tariffs, and on our labour force in the way of staff shortages and salary cost pressures. In addition, whilst significant changes to produce standards and legislative requirements more generally are not anticipated in the short term, they could impact the Group if introduced in future. We are taking actions to assess and mitigate against any impact of Brexit, including engaging with key suppliers and wholesalers to identify Brexit readiness, stock levels, labour strategies and remediation plans.

Where possible, we seek to absorb price increases through operational efficiencies, and cost indexation in our contracts also gives us the contractual right to review pricing with our clients. We are experiencing a challenging macroeconomic environment in some of our regions and a result, we are taking prompt action to ensure that we have the right sized labour model for the future.

The Group faces a number of operational risks on an ongoing basis such as litigation and financial (including liquidity and credit) risk and some wider risks, for example, environmental and reputational. Additionally, there are risks (such as those relating to the eurozone economy, pensions, and acquisitions and investments) which vary in importance depending on changing conditions.

In accordance with the provisions of the UK Corporate Governance Code 2016, the Board has taken into consideration the principal risks in the context of determining whether to adopt the going concern basis of accounting and when assessing the prospects of the Company for the purpose of preparing the viability statement. The going concern and viability statements can be found on page 40 of the Strategic Report. All risks disclosed in previous years can be found in the annual reports available on our website www.compass-group.com. We recognise that these risks remain important to the business and they are kept under review. However, we have focused the disclosures on pages 19 to 21 on those risks that are currently considered to be more significant to the Group. 

Principal Risks

Principal risks

·; Increased risk Static risk

Principal Risks (continued)

ECONOMIC AND POLITICAL ENVIRONMENT

Principal Risks (continued)

Compass Group PLC

Consolidated Financial Statements

Compass Group PLC

Consolidated Financial Statements (continued)

Compass Group PLC

Consolidated Financial Statements (continued)

1 Own shares held by the Group represent 187,455 ordinary shares in Compass Group PLC (2018: nil ordinary shares) and are held by the Compass Group All Share Schemes Trust (ASST). These shares are listed on a recognised stock exchange and their market value at 30 September 2019 was £3.9 million (2018: £nil). The nominal value held at 30 September 2019 was £20,714 (2018: £nil).

2 The Group has adopted IFRS 15 'Revenue from contracts with customers' and IFRS 9 'Financial instruments' effective for the year ended 30 September 2019. IFRS 15 has been applied retrospectively and comparatives for the prior year have been restated, whilst IFRS 9 has been applied prospectively from 1 October 2018 by adjusting the opening balance sheet at that date. Additional information about the transitional impact of these standards is included in note 2.

Compass Group PLC

Consolidated Financial Statements (continued)

1 Prior year comparatives have been restated upon the Group's adoption of IFRS 15 'Revenue from contracts with customers'. See note 2 for details regarding the restatement.

Compass Group PLC

Consolidated Financial Statements (continued)

1 Prior year comparatives have been restated upon the Group's adoption of IFRS 15 'Revenue from contracts with customers'. See note 2 for details regarding the restatement.

2 Component of net debt.

Approved by the Board of Directors on 26 November 2019 and signed on its behalf by

DOMINIC BLAKEMORE, Director

KAREN WITTS, Director 

Compass Group PLC

Consolidated Financial Statements (continued)

Compass Group PLC

Consolidated Financial Statements (continued)