Business Breakdowns
· 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?
· Asif Jeevanjee
[00:00:00] S1: So the typical margin in the food service sector is around 6%. Aramark makes about 6%. Sodexo a little bit under that. But that's partly because of the dilutive effect of its facilities management business. Compass outside North America also makes about a 6% margin. But in North America they make a more than 8% margin. And what explains this 200 basis point spread? There are several contributing factors. The key one is scale. We've got a fixed managerial cost and technological infrastructure cost. And the more revenue you layer on top of that, the higher your margin is going to go. In addition, Compass has embedded within it an economies-scale-share type of model within the procurement side of the business. And I think that partly also explains the margin differential, although it mainly explains the ability to grow the business. And that drives scale and that drives margin. Just to delve into that, in the early 2000s, Compass acquired a small food procurement technology business called Foodbuy. And that has formed the bedrock of Compass's GPO or general purchasing organization. And the way this works is that most of the ingredients purchased by the Compass chefs are bought through Foodbuy via approved vendors. And as you can imagine, that by itself is a lot of volume. But in addition, Compass invited third parties, these could be cafes, restaurants, hotels, et cetera, to also procure through Foodbuy. Today in total, Foodbuy does about $40 billion volume, 60% of that coming from third parties. And that enables Compass to secure better prices and better payment terms from their suppliers. As an aside, Compass charges third parties a very small fee for using Foodbuy, which I like to think is a slightly Costco-esque touch. And it's a really compelling win-win for everyone involved. Compass attains lower procurement costs which help them win more business, further driving up scale. Third parties can access Compass's buying power and reduce their cost of goods sold in a way they couldn't have done otherwise. The consumer enjoys a lower priced meal and if they're happy, then all else equal, the client will be happy. Even the supplier is content with this arrangement because although they might sell at lower prices, they also have certainty about demand, which is particularly important when you're dealing with perishables.
· Asif Jeevanjee, Matt Reustle
And this model is very difficult for other players to compete with or to replicate. And now Compass is ramping up Foodbuy in Europe and this dovetails really nicely with the acquisition strategy that will bring scale in core markets like the UK, Germany, France, the Nordics, et cetera. That will enhance procurement volume in each of those countries. This ought to lead to more growth, which will drive up the European margin in the direction of the North American level over time. [00:00:00] S0: It's impressive to see. We always use the AWS example in terms of something you need for yourself and eventually being able to sell it elsewhere. But interesting to hear and why that would be so attractive as an added model to the system and to the business profile. On the cost point, you mentioned something there around food buying, purchasing. In terms of inventory risk, this is always something, I walk through a grocery store and I just think to myself, all of this produce, it's perishable. How do they possibly model out inventory management? And I never spend enough time to understand the real ins and outs of it, but it just weighs on me. How does that come into play, if at all, for Compass?
· Asif Jeevanjee
[00:00:00] S1: That's a really great point. And one of the things I think Compass is slightly advantaged on is the way their model works versus say, a restaurant. A restaurant is a spot business, but Compass is a contractual business. Compass is able to menu plan, let's say, for the week ahead, and then all of their chefs at the site level will order from Foodbuy. The inventory turns are quite high. Inventory represents less than 2% of sales. It's not going to be sitting within the business very long. It's mainly perishable. There might be some food that sits in the fridge for a while, but it's going to be used according to the menu that's already been planned out. And because you have a mainly captive customer base, you sort of know what your covers are going to be, if you like the equivalent in the restaurant business. So it's a very different business from that point of view. But I think inventory isn't really a huge part of the story. From a working capital point of view, though, what's interesting and again difference with the restaurant industry is that working capital is negative for Compass, so effectively they're able to pay suppliers later than they're collecting from the clients and consumers. And that's really a very attractive feature of the business, particularly as it seems to continue to grow and grow.