Hello, welcome to the Compass Group third quarter trading update call. Throughout the call, all participants will be in listen-only mode. Afterwards, there will be an opportunity for a question-and-answer session. Just to remind you, this conference call is being recorded. Today, I am pleased to present Mr. Dominic Blakemore, CEO, and Mr. Johnny Thomson, Group Finance Director. Please go ahead with your meeting.
Good morning, ladies and gentlemen. Thank you all for dialing in. With me this morning, I have our Group Finance Director, Johnny Thomson. I'm sure you've all read the statement. I'll give you a brief overview of our performance and outlook before opening the call to questions. Compass continues to trade well. Our full-year expectations are unchanged. Organic revenue grew 5.7% in the third quarter, or 5.1% if we exclude the impact of Easter. Performance was driven by strong net new business in North America, an acceleration in Europe, and good progress in the Rest of the World. We continue to generate efficiencies across the group, which resulted in margin improvements in the third quarter. We remain on track to deliver modest margin improvement for the full year.
Looking at each region in turn, performance in North America continues to be strong, with organic revenue up by 7%, or 6.6% excluding the effect of Easter. We saw particularly strong growth in Business & Industry, vending, and Healthcare, which was partly offset by the impact of timing of certain Sports & Leisure events. These will benefit in Q4, along with the mobilization of some good contract wins in Education. Year-to-date margins were stable. Organic revenue in Europe grew by 3.2% in the quarter, or 2% excluding Easter, driven by an acceleration of net new business in the U.K. Although the benefits of the cost actions taken to offset above-average inflation in the U.K. are coming through and benefiting margins, they were offset by a more challenging volume and cost environment in the U.K. In Rest of the World, organic revenue increased by 3.1%, or 2.7% excluding Easter.
Growth was driven by strong performances in Turkey, India, China, and our Spanish-speaking Latin American businesses. Better-than-expected efficiencies and improved overhead leverage in growing markets resulted in strong margin improvements in the quarter. A quick update on currency. If current spot rates continue for the remainder of the year, foreign exchange translation would negatively impact full-year 2017 revenue by around GBP 984 million, and operating profit by GBP 77 million. In summary, Compass continues to have a good year. Performance in North America is strong. Europe is accelerating as expected. Rest of world is progressing well. Better-than-planned margin improvements in rest of world is offsetting a more difficult volume and cost environment in Europe. As a result, our full-year expectations are unchanged, with organic growth above the middle of our 4%-6% range and modest margin progression.
In the longer term, we remain excited about the significant structural growth opportunities globally, the potential for further revenue and margin improvements, along with continued returns to shareholders. Thank you, now we'd be happy to take your questions.
Thank you. Ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, please press star one to ask a question. We will pause for just a moment to allow everyone an opportunity to signal. Thank you. We will take our first question today from Jamie Rollo of Morgan Stanley. Please go ahead, sir. Your line is open.
Hi there. Morning, everyone. A few questions, please. First, could you elaborate a bit more on what's happened in the U.K., particularly the comment on the recent volumes deteriorating? What's changing? Is that a market issue? Is that an economy issue? Historically, Compass has dealt very well with unforeseen events, but it looks like this is perhaps a tougher environment. What's happening, please? The other question was on the rest of world margin performance, where Q3 looks very good, up around 100 basis points. I'm just wondering how sustainable that is, particularly as we look at margin progressions for 2019. Thank you.
Great. Thank you, Jamie, I'll hand those two over to Johnny.
I think the first thing I would say, Jamie, is that we're pleased with the actions we have taken, and we discussed at the half-year, and we're definitely seeing the benefits. In U.K., I'm talking now. We're definitely seeing the benefits of those actions coming through. As Dominic said earlier, we are seeing a more challenging trading environment in the U.K. than we expected. Perhaps the cost inflation continues to be higher than we had anticipated. I think more importantly, we are seeing our like-for-like volumes coming off. As you know, the drop-through on volume to our profit level and margins is fairly significant. What that means, of course, as you point out correctly, is that we're having to work hard.
Therefore, we're still confident that the U.K. margin will come through, perhaps a fraction later than we anticipated at the half-year, but it will come through. Therefore, what I think you'll see is quarter four European margins much stronger, perhaps even into positive. A nice carry into next year. It's definitely a tougher environment in the U.K. In terms of the rest of the world, we're really pleased about the margin progress. I think I've highlighted this over the last few reporting periods. We obviously did the restructuring, but through the commodity cycle, we haven't been standing still. We've been working hard on pricing and productivity to make sure that our margins continue to face into the commodity cycle. As that cycle starts to ease, of course, we then see the benefits of that coming through.
On top of that, as Dominic mentioned earlier, we do have the benefit of leverage as some of those businesses now come back into growth. Looking out further on margins in the rest of world, of course, you would expect me to say these kind of margins aren't necessarily sustainable. We do have the benefits in these quarters of the construction project in Australia, which has taken longer to flow into production than we expected, and therefore we're having higher than expected margins than we anticipated. That will roll off, and therefore our carry on rest of world margins won't be quite at this level.
Jamie, I'd just add to that a couple of points. Firstly, we're really pleased with the growth in the U.K. The growth in the U.K. in the third quarter has accelerated, and we anticipate that acceleration into the fourth quarter and next year. I think that's very important. I think secondly, it shouldn't be a surprise that volumes are slightly under pressure. We're seeing it on the high street, and we are taking actions and are monitoring that as we go. Finally, I think it's really important that we manage our total portfolio of businesses, and therefore, we're seeing the strong performance in the rest of the world allowing us to offset that in the U.K. As we look forward, as we said this morning, we continue to expect margin progression as we go ahead.
The U.K. volume issue is really a consumer sort of marketplace issue. There's nothing specific about contract catering or Compass.
We don't think so. We're obviously tracking it, and we've seen those negative volumes slightly accelerate in the third quarter. I think we're seeing it on the high street. Perhaps part of that is price related. I think part of it is consumer confidence. Perhaps there's a little bit of business confidence in there as well at the moment. We're just being careful as we work through this environment. Certainly not-
And on-
Compass or contract catering related.
Okay. On 2019 margins for Europe, if this year's guidance has moved from -15 basis points to -40 basis points, but the U.K. is on track just a bit slower to get those savings through, should next year be up 25 basis points or so?
No. This year, just to be clear, we've moved the guidance for Europe as a whole to -50 basis points on Europe. I said a bit earlier, we will see some progression in quarter four. I think once you get into 2019, you should expect us to get back to what we would typically see from a European model, which would be modest, say, five-ish basis points worth of margin improvement in Europe.
Okay. Thank you very much.
Thanks, Jamie.
Thank you. We take our next question from Lina Taggart of HSBC. Please go ahead.
Morning. Thanks. I think I've got 3 questions as well. Firstly, just in terms of the Sports & Leisure impact in North America, I wonder if you could quantify that for us for the quarter. Secondly, sorry to sort of go back to the U.K. like-for-like volumes again, but I'm just slightly baffled about that. Has it got something to do with the warm weather, or are you sort of seeing any structural changes with people working from home more or anything to do with the football? I'm just trying to understand better why those volumes will have fallen. Finally, excuse me.
Just in terms of cost inflation and pushing that through in your contract, can you sort of remind us as to how the mechanics work and why in some cases it seems to be quite difficult to pass through either staff or food cost inflation in those contracts? Thank you.
Sure. Let me take the first couple of questions, Lina, I'll pass on to Johnny on cost inflation. Firstly, we're not going to quantify the impact of the Sports & Leisure events timing. There are a couple of significant impacts. The Major League Baseball season is starting in quarter four this year, whereas it started in quarter three. I think there's a major motor racing event in Las Vegas, which again falls into quarter four rather than quarter three. I think we're very clear that there is cause and effect there. I think more important, we anticipate that North America's growth rates on a full year basis will accelerate from the 7.2% we've seen today, possibly by a further 20 basis points or so.
That implies a run rate in the fourth quarter that will be towards 8%, which I think is very, very exciting, driven not least by the timing of Sports & Leisure, but also some great wins in the Education sector, which we'll mobilize in the fourth quarter. I think that's really important, and we're very excited. I don't think we should get hung up on the timing of Sports & Leisure events because they can impact quarters with reasonably small numbers. I think that trend into the fourth quarter and beyond is what's important. Secondly, on the U.K. like-for-like, I slightly disagree with you on the point about the high street impact. I think the high street impact is a lot about the cost inflation that we're seeing at the moment, as well as some consumer trends.
I do think that that is perhaps also playing into our captive catering environment. Secondly, you may have a point on weather and World Cup, if that's the case, then perhaps things will get a touch better. I think we're more focused on what we think is an underlying trend of slightly lower spend and slightly lower footfall into our restaurants.
I'll just pick up on the cost inflation and pass-through point contract. The first thing I'd say is that we focus first and foremost on mitigating cost inflation through our own actions on cost, and that's a very important part of our model before we get to pricing to ensure our clients the best value proposition. We've always got ahead of that and done that quickly in the past, and we expect to do so in this case as well. Coming back specifically to your question, we have, in general, 3 contract types. They would be cost plus, P&L, and fixed price. In the first two, while we have some negotiations with clients to do, in general, we have much more sovereignty of pricing, and therefore, it's easier for us to pass it on.
In the last case, the fixed price case, we have much more negotiation to do with our clients, therefore, it can take just slightly longer to do. That, I would say, would be particularly the case in the U.K. and would be particularly the case in some of our support services contracts, which are much more labor-orientated and do take longer to negotiate.
Okay. That's very helpful. Thank you.
Thank you. We take our next question from Kean Marden of Jefferies. Please go ahead. Your line is open.
Morning. Just touching on Johnny's last comment there. Could you maybe elaborate on the relative trading position in the U.K. support services businesses versus food? I guess, have you seen a profit shortfall or trading shortfall in some of the non-core businesses that you're looking to divest?
Yeah, those non-core businesses are what? Just around 10% of our total U.K. revenues. The trading has been a touch more difficult, as Johnny outlined. Yes, the cost inflation environment is more difficult to manage in that particular part of our business. I'd say it's probably slightly below our expectations for the year. As we said before, we've got ongoing processes to look at how we might exit or sell those businesses.
I presume if you had any comments to make regarding disposal process then you would have made them in today's statement?
Yes. As we said at the half-year, we are evaluating those businesses across the group that we do want to exit or sell. We started on that process. There's nothing to report in terms of our quarter three, although since quarter three, we have sold a small business in North America. It started. We would expect by November to be able to announce a few more. Although, of course, that will depend on the circumstances of each of the deals that we're doing. I would hope that we can. The rest will flow through into 2019. It's very much on track with what we expect.
Fantastic. Thanks very much.
Thank you. We now move to David Holmes of Bank of America Merrill Lynch. Please go ahead, sir.
Hey, morning, guys. I just wanted to touch on North American organic growth. You seem really confident on the acceleration into Q4, and the commentary on the pipeline has been very positive. How do you think about that momentum carrying through into 2019?
Yeah, you're right. We are anticipating a strong fourth quarter. Obviously, a little bit of that is timing, as we said earlier today. What we will see, though, is we're going to see some good growth coming through in the Higher Education sector in particular, but we'll also see the runoff of some of the big Healthcare wins that was a feature of our growth during the course of 2018. I think in the round, we continue to look at momentum in the U.S. sort of broadly in line with where we've been this year, so sort of towards the 7% level. That remains our expectations again for next year.
Cool. Thank you very much.
Thank you. We now move to Richard Clarke of Bernstein. Please go ahead. Your line is open.
Good morning. Two questions from me. You've retained your guidance on the modest margin progression for the full year, but you're clearly taking down the Europe guidance at the same time. Has anything across the group softened a little bit, and is that being offset by currency, per se? If you hadn't had the dollar boost, would you be able to stick with your modest margin progression? Is there any update on the new CFO and the process of looking for a new CFO at this point?
Firstly, let's be absolutely clear. We are maintaining our margin guidance for the year as we have done throughout the year. I hope we've made it clear today that, yes, Europe is a bit tougher, but we're doing better in Rest of World. The portfolio is allowing us to offset that. It isn't about FX as we obviously change our guidance as a result of the weakening of sterling against the numbers we've previously given you. That flows in addition to the guidance we've given. Hopefully that sort of clarifies the point. Absolutely, we are maintaining our margin guidance. We have made progress in the third quarter. We have some modest margin progression in the third quarter. Therefore, we've improved in the year to date, and we expect to make a few basis points of margin progression on a full year basis.
With regards to the CFO, we have commenced that search. It is underway. Obviously we will update you as we go forward should there be any news. Obviously, we have Johnny alongside me. He's here with me until the end of this calendar year and remains totally committed. Thanks very much.
Hello, Mr. Burrus. Your line is open.
Sorry, I didn't hear the intro. I had two questions please, on margin. Just a big picture thing. Looking at the math, I was estimating that to get to slight growth for the full year, you'd need about 20 basis points positive in Q4. Does that sound about right? Will that all come from Europe? The second question was just if you could give updated guidance on rest of the world margin in the same way that you did to the question on Europe earlier. Thanks very much.
Yeah. Your first question, you're pretty much spot on on the 20 basis points. However, it's not all coming from Europe. As I said earlier, we're anticipating and positive about Europe improvements in the fourth quarter on margin. We're also carrying a very strong margin performance from rest of the world into quarter four too. We feel really good about the quarter four performance, and that's why we're confirming our full year guidance. In terms of rest of the world, as I said earlier, we've got 100 basis points-ish in quarter three and quarter four. That's not going to be sustainable into next year. There are some underlying improvements which will continue, which I mentioned earlier in the call.
However, we are anticipating that a big construction project in Australia will move into production either quarter four or quarter one next year. That will significantly bring rest of world margins down.
Okay. Thank you.
Thank you. We now move to Tim Ramskill of Credit Suisse. Please go ahead. Hello, Mr. Tim Ramskill. Your line is open, sir.
Sorry. Apologies, I was on mute. Three questions from me, please. Maybe, Johnny, you could just go back to that point about the contract in Australia in terms of maybe just a bit of help in terms of how much of a margin drag that might have, but also what that might help to contribute in terms of rest of world growth next year. Second question was around the planned circa 5% exits, which obviously you talked about at H1. I think a number of investors have been asking what the financial implication of that might be. Presumably, I know you've said these are decent margin businesses, but they're obviously in subscale territories or businesses where margins aren't potentially going to get any better. How would you expect that 5% exit process net of some disposal proceeds as well to flow through in terms of an earnings impact?
The final question is, maybe you could just take the opportunity to give us your thoughts on the outlook for Europe, more medium term, given it has been a little bit volatile over the course of the last few years. I know it's tricky to read, but what's your current thinking on the medium-term prospects?
Just-
Do you want me to Tim, let me take the second and third question, then we'll come back to the question on the impact of the contracts in Australia. Just with regard to the exit program, yes, we talked about it being up to 5%. I think that remains broadly the case. We have got, as we have said, a number of ongoing processes. You should expect us to be able to provide a fuller update when we come to the year end. We said that they are broadly in the round margin neutral to the group. There is obviously a range of operating margins of those particular countries or subsectors. Depending on the timing, you will see the impact of those.
I think it's clearly fair to say that we're unlikely to achieve a Compass multiple on those businesses. We will update you as we go on the proceeds we receive for the businesses. I think what's really, really important in all of this for me is that it's quite a long tail. It is distractive of management. I think that this will really allow us to focus on our core businesses where we see better medium and long-term growth prospects, better medium and long-term margin opportunities, and it will allow us to deploy the best practice processes more consistently across that smaller core of markets. I think that's where the benefit absolutely comes in my eyes. We will give you a fuller update when we get to November on that.
Secondly, for me on Europe and the medium-term prospects, I think things are looking within continental Europe, so excluding the U.K. from a growth perspective, slightly better for us. We have had a dull year this year. We're expecting a better fourth quarter. As it looks today, our retention rates in a number of the major European markets are strengthening. We continue to win good levels of new business. I think we're hopeful that we will see an improved performance in continental Europe as we look forward into next year and continue the efforts we've talked about in terms of building out subsector brands and creating the scale that allows us to be more efficient in the European markets. I think that's something that we will hopefully be talking to you about as we move forwards. Then finally on the O&R contract in Australia, Johnny?
I think the first thing I'd say, Tim, is that we're really excited about the way the rest of the world business is developing. We've obviously had two years of quite a tough environment. We've been battling that hard. We're very pleased to see some of the fruits of that labor coming through. As we go forward, that will come through stronger in the top line. We will continue to have margin improvements. As I said earlier, it won't be quite at these levels.
First of all, because of course, we'll be lapping some of the benefits that we'll be taking this year from the restructuring. As you point out, also because of the move from construction to production in Australia. I would say that as guidance for next year, to give you a steer, our rest of world margins should improve by around 20 basis points, which again, we feel very positive about.
Excellent. Thank you.
Thank you. We will now take our final question today from Jarrod Castle of UBS. Please go ahead.
Thank you. Good morning, gentlemen. Something which is topical at the moment in the press, going into 2019, it seems like the government's potentially making contingency plans for a hard Brexit. I am very interested to get your thoughts on obviously, a core part of your business is supply chain management. Getting an idea of how much of the U.K. input is from local producers versus Europeans and how you are thinking about that. Secondly, I don't know if you have or if you can give any further color on how your CapEx to sales is progressing. Is it on track versus guidance at 1H?
Lastly, sorry, I missed the first part of the call, I don't know if someone's asked this, in terms of your energy and commodities businesses, is that coming back given the sustained relatively high oil price? Thanks.
Jarrod, let me tackle the first question, then I'll hand over to Johnny for the CapEx and commodities question. Firstly, with regard to, you're absolutely right, the media coverage around contingency plans for food and beverage management by the government. It is obviously something that we've been thinking about and looking at for a while. Our supply mix is broadly 60%-65% U.K. sourced, with 35%-40% either Europe or other. And that would be direct and indirect supply. We are obviously looking at what different deal scenarios could mean, and therefore, the contingency planning we need in place to address that. Some of that will be about understanding how we can swap product, how we can source U.K. product, how we can build inventory where necessary, and also where we can agree longer term supply deals.
There's a combination of actions going on. The planning is in hand, and I guess we will just have to work with whatever outcome of the negotiations emerges. I think rest assured, we are certainly in the planning and contingency mode.
Just on the CapEx, I would anticipate that our CapEx this year would be at the top end of the range that we discussed at the half-year, around about 3.5%. First of all, of course, you knew about the Dodgers investments that we made earlier in the year, and we talked about. As Dominic also mentioned, we've had some really exciting wins in the Education sector in North America, with a little bit of CapEx in Quarter Four too. We should be there or thereabouts at the top end of the guidance on CapEx. As we look beyond that, we still stick to that guidance of up to 3.5%. Probably a fair assumption in the absence of a Dodgers would be somewhere between 3% and 3.5% into next year.
Just on your commodities question, year to date, our commodities business has declined by about 2%, which is actually a little better than we'd expected. As we said earlier, the roll-off of the construction process in Australia has just taken a little longer than we expected. As we look into next year, that will roll off and will have an impact on how quickly our business gets back into growth. However, in the medium term, we would expect to be lapping and therefore that business to come into growth. What we're not seeing necessarily is a significant amount of capital reinvestment from our clients, and therefore I would expect that growth to continue to be modest. We still had a great business, and I guess having come through this, it's now a much smaller part of the group as well, at around 5%.
It will come into growth in the latter part of 2018-2019.
Okay. Thanks very much.
Thank you. Ladies and gentlemen, that will conclude today's conference call. On behalf of the Compass Group, we'd like to thank you for your participation.