Business Breakdowns
· Asif Jeevanjee
[00:00:00] S1: That's right. Sectorization is a really interesting approach and it enables a number of benefits. So one is the ability to use reference contracts in a pitch more effectively. If a potential client is, say, a hospital system, Compass can show them what they've accomplished in another hospital system of a similar size, maybe in the same state. And that's much more persuasive than showing something generic or from a different sector. And down to the site level, contracts are very bespoke and Compass's brand and sectorization approach has really helped with that. In fact, it has been so effective that Compass has taken things to the next level and sub-sectorized the business. So today, Compass operates along 27 sub-sectoral lines. I've got a fun story to illustrate that this really is how Compass functions. During the pandemic, Compass, along with the rest of the sector, was under intense pressure due to the lockdowns. And I had a hunch that if Compass were feeling the heat, then the self-operated part of the market were going to be feeling it even more keenly and that that might actually drive more outsourcing. To test the theory, I commissioned a survey to ask various organizations whether or not they currently outsource their catering, and if not, whether they planned to do so. And if they did plan to outsource, who were they considering partnering with? Was it Compass? Was it Aramark, Sodexo or someone else? When the results of the survey came back, they did indeed show that many organizations were contemplating subcontracting out their currently in-house operation. But Compass hardly came up as a choice. This was a bit of a head scratcher. And then it hit me that whilst we investors know who Compass is, the decision makers at the clients don't necessarily know the name Compass. They deal at the subsector level with brands like Bon Appetit and Flik and Morrison and Chartwells and so on. And a revised questionnaire did bear this out. So that was quite a nice proof point about sectorization.
· Matt Reustle
[00:00:00] S0: On the point of market penetration, the adoption of food services, whether it's versus the alternative of providing in-house services or just not having any services at all. Do you have any sense of where that stands today in terms of market penetration and however that might be measured?
· Asif Jeevanjee
[00:00:00] S1: If we focus firstly on the North American market. As I said, one of the things that drove Compass to really launch in North America was recognizing that the market was outsourcing, but that was really focused on B&I. So you can imagine companies in the 80s and 90s saying, why are we doing this in house? We should really outsource this. We'll save money and it's really not core to our business. That sort of wave of outsourcing has pretty much happened and today almost 100% of B&I, the marketplace is fully outsourced. It has yet to happen within two very important markets, which is healthcare and education. There, probably in North America, about half the market is outsourced. That's what's continuing to drive Compass's quite high rate of new business wins is increasingly and particularly after the pandemic, those clients are saying we really need to outsource this. And one of the things that's driving that decision is, first of all it's cost. Compass's scale in procurement is so big that they're always going to be able to deliver food more cheaply than an in-house operation. But the other is just rising complexity. Consumers are getting more demanding. They want to know more about the food they're putting in their bodies. They have nutritional demands, whether it's around vegan or gluten free. They want to see labeling around allergens, and that's particularly important in the healthcare and education space. And it's quite hard to deliver on that. You need to have a very good eye on your supply chain. You need to have a lot of data that requires a lot of technology and it's becoming more and more difficult for a single site operator or even a small regional player to really compete. So that's driving a second wave of outsourcing now, in healthcare and education in North America. What's really interesting though at the moment, is that for many many years continental Europe was quite reluctant to outsource. It did happen to quite an extent within B&I, but certainly not the other sectors so much. And that is now changing. Compass recognized that. They've been investing very heavily in Europe in acquisitions in particular, replicating the successful strategy that they executed in the 90s and 2000s in the US. What you're starting to see is really an acceleration in organic growth to levels that we've almost never seen in Europe.
· Asif Jeevanjee, Matt Reustle
I think that's really a repeat of the strategy that's already played out in the US. [00:00:00] S0: It's interesting when you talk about acquisitive DNA to go from a period where that seemed to be a theme in the 90s. I'm sure there was some M&A over the years in between now and then, but to go back to that time period and have a precedent like that, it's a little bit further back in time than most companies would point to in terms of executing a strategy. But it seems like a lot of the DNA is still in place. I want to get into the M&A point a little bit more. But before we move on, in terms of the market size and growth, is there a way to measure how much the market is growing organically each year? I can understand there's going to be contracts that are moving from one provider to the next, but is there some sense in terms of what organic growth is for the market as a whole, whether you break that down geographically or at the world level?
· Asif Jeevanjee
[00:00:00] S1: It's tricky to do that because you've got to assess what is the market. But if I look at Compass specifically, we can tease out what are the elements of growth. There are several elements to their organic growth. One is volume growth. It's pretty hard to eke out more than a few basis points, really, a year from that, because the biggest way you can grow there is to convince people who maybe aren't using their cafeteria every day of the week to use it more often. So that's a very small contributor to growth, but it has been a positive one. The second one is pricing. Compass generally is passing on pricing to the consumer that's broadly in line with inflation. They're certainly not trying to use pricing as an important lever because actually what they really want to do is to try and reduce costs so that they don't have to do that, but they're able to pass on inflationary costs to the consumer. And you've seen that particularly in the last few years when you had quite high food inflation and high labor inflation. They were able to pass that on. Over time, that's been sort of around the 2% type level. The really big driver of organic growth has been what they call net new business wins. I mentioned earlier that retention is around 96%. Compass has been growing net new business at around 4%. So that requires a gross win rate of about 8%, which is on that sales base, absolutely enormous. And they've been doing that to end up at a net new of about 4%. Mid to high single digit organic growth is certainly possible for a very long time for Compass.
· Matt Reustle
[00:00:00] S0: I want to get into the financial dynamics because I think that will instruct some of the M&A conversation as well. You gave a good sense of the top line growth there. One of the benefits of a large player in this market should be the cost structure being more efficient. What does it actually look like in terms of the margin profile of this business and however you might categorize how Compass performs, how the industry performs and the most important metrics associated with the margin profile?