Compass Group H1 2020 Earnings Report

Compass Group EPS Results

• Actual EPS: GBX 37.60
• Consensus EPS: GBX 36.20
• Beat/Miss: Beat by +GBX 1.40
• One Year Ago EPS: N/A

Compass Group Revenue Results

• Actual Revenue: N/A
• Expected Revenue: N/A
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

Compass Group Announcement Details

• Quarter: H1 2020
• Date: 5/19/2020
• Time: Before Market Opens
• Conference Call Date: Tuesday, May 19, 2020
• Conference Call Time: 3:00AM ET

Compass Group (LON:CPG) is a global leader in food services, operating in over 25 countries, with over 590,000 employees worldwide and generating underlying revenues of over $46 billion for the 2025 fiscal year. The company's primary listing is the London Stock Exchange and also trades on OTCQX® Best Market. Our core offer is the provision of outsourced food services and targeted support services across the world. Compass operates across five sectors: Business & Industry, Healthcare & Senior Living, Education, Sports & Leisure, and Defence, Offshore & Remote, using a portfolio of bespoke B2B brands. Our vision is to be a world-class provider of outsourced food services and targeted support services, renowned for our great people, our great service, and our great results.

Compass Group H1 2020 Earnings Call Transcript

Key Takeaways

• 50% of revenue suspended in April due to COVID-19 lockdowns, creating significant operational uncertainty around the timing and pace of recovery.
• Implementing aggressive cost measures including £500 million per month of savings, reduced CapEx, paused M&A activity, and suspended dividends to preserve cash.
• Equity raise of £2 billion, increased committed facilities to £2.8 billion, and secured covenant waivers to strengthen liquidity, reduce leverage, and enhance financial resilience.
• 23% drop-through margin achieved in April is deemed sustainably operational and within the previously stated 25%-30% target range, with a shift now toward margin recovery as volumes return.
• Accelerating adaptation efforts with health & safety protocols, digital solutions, and best practices from China to support phased site reopenings and position for long-term organic growth.

Presentation

[Dominic Blakemore, Group CEO at Compass Group]

Thank you very much. Good morning. I'm joined this morning by Karen Witts, our CFO. Before opening the call to questions, I'd like to say a few words on the results and the placing. We came into this pandemic on the back of our strongest performance in many years. As you know, we grew 6% organically over the past two years, and we were growing at 6% organically with 10 basis points of margin progression in the first five months of this financial year. The crisis is placing significant pressure on the business, and during the course of April, we have around 50% of our revenue suspended. The outlook remains uncertain, both in terms of the length of the lockdown measures and what the relaxation of those containment measures, the impact it may have on our business as well as on the economy thereafter.

[Dominic Blakemore, Group CEO at Compass Group]

We've acted quickly and decisively to put the business on the very best possible footing by reducing costs by GBP 500 million per month, protecting cash by reducing CapEx, pausing M&A, and suspending the dividend. We've strengthened our liquidity by increasing our committed facilities by GBP 800 million to GBP 2.8 billion. We've now obtained waivers from our US private placement investors for our next two leverage covenant tests. We remain extremely confident in our medium and long-term prospects and the Compass model of creating long-term shareholder value. We'll target steady and sustainable organic revenue growth combined with industry-leading margins. We invest in the business to support our organic revenue growth with CapEx and infill acquisitions. Finally, and importantly, we reward our shareholders with an ordinary dividend and return surplus cash as appropriate. However, we need to reduce our leverage to increase our resilience.

[Dominic Blakemore, Group CEO at Compass Group]

The equity raise, combined with the steps we've already taken, will allow us to weather the crisis while continuing to invest in the business, adapting our sites to the new normal, reducing costs, enhancing our competitive advantages, and supporting those long-term growth prospects. We believe this will put us in a strong position in the recovery and further consolidate our position as the industry leader in food services. Thank you, and now we're happy to take your questions.

[Operator]

Thank you. As a reminder, if you wish to ask a question, please press star one on your telephone keypad. We will now take our first question from Jamie Rollo from Morgan Stanley. Please go ahead.

[Jamie Rollo, Analyst at Morgan Stanley]

Morning, everyone. I hope everyone's well. Three questions, please. The first one, just sort of curious as to why equity, not debt. You've been pretty clear you're cautious on the outlook, but the company has pretty good liquidity anyway, and you came into the crisis with low leverage, and you seem to have taken down your long-term leverage target a little as you move that to a post IFRS 16 basis. I'm just wondering, is it concern about any longer-term structural change in contract catering, or is there something else that we should be thinking about? Secondly, on the cash burn, if I look at that liquidity table where you've gone up from GBP 2.5 billion to GBP 3 billion between the end of March and the end of April, despite the GBP 800 million RCF, it looks like the cash burn was about GBP 250 million in April.

[Jamie Rollo, Analyst at Morgan Stanley]

Is that right? Is that the sort of run rate we're thinking about? If you could sort of mention working capital and any exceptionals within that conversation. Finally, there's a quite good 23%, a very good 23% April flow through margin. Is that the sort of figure we should think about going forwards? What sort of margin do we think about for the group under those stress scenarios? Thank you.

[Dominic Blakemore, Group CEO at Compass Group]

Thank you, Jamie, and good morning. If I take the first and third question and then pass to Karen for the second. First of all, on the question of why equity, not debt. Look, we've clearly considered all of our options. This step isn't about liquidity. It's about reducing leverage, and it's about introducing resilience such that we can withstand whatever the next 12 to 18 months could look like, and also emerge the other side with a business that we continue to invest in. We want to reduce our leverage back down to the range that we've traded at historically, which is one to one and a half times. Yes, on the new IFRS 16 basis, I think it's a fraction more conservative than the past. It isn't in any way a signal of concern about our industry or sector.

[Dominic Blakemore, Group CEO at Compass Group]

It's the desire to trade with the same values that Compass has always had of conservatism and resilience. With regard to comments about the sector, look, right now 50% of the business is suspended. We need to work through the recovery of volumes. In the near term, it's going to be about how we adapt to social distance and the health and safety protocols that will be required on-site, and therefore what that means for volumes on-site. In the longer term, yes, we'll have to understand what remote working, remote learning has meant for our sectors. We do believe that the people will return to those sites, and the opportunity for us to provide enhanced services and more valued services will be there. In terms of drop-through, yeah, we're very pleased with what we've achieved. We set out a range of 25%-30%. We're now at 23%.

[Dominic Blakemore, Group CEO at Compass Group]

We believe that is sustainable operationally and isn't resulting from any one-offs at all. That's a pure operational number. We'll obviously work hard to further improve it. We quickly need to move away from a focus on drop-through to a focus on margin. The journey now over this next phase is, as we recover volumes, how we recover margin. I believe in that there are three levers to pull. One is reducing our costs within the volume environment. The second is addressing our commercial arrangements, so we're best protected to a lower volume environment. Then obviously it's being poised to welcome the volumes back into the system as they come. If I could pass over to Karen for the cash burn question.

[Karen Witts, CFO at Compass Group]

Yeah, sure. You asked the question about the situation in April, Jamie. Effectively, the cash burn is obviously very dependent on the amount of business that is open or closed. At April, about 50% of the business was closed. With 50% of the business closed, our operational cash burn is in the region of GBP 100 million-GBP 150 million a month. Clearly our cash flows are a bit lumpy. What we are also seeing in the short term, and you did refer to working capital, is a working capital unwind. Typically at the half year and the full year, we would have negative working capital to the tune of about GBP 100 million. You'll have seen in the half year results that that negative working capital is GBP 300 million.

[Karen Witts, CFO at Compass Group]

That is a function of the fact that about a third of our business is cash sales. When you don't have the cash sales, then your debtors, all other things being equal, stay quite stable and your trade creditors, which are on 30, 60 or 90-day terms, unwind. With a 90-day unwind, we would have a total outflow, including what you saw in March, of about GBP 800 million. If you just did that on a rough monthly basis, then you can get to the kinds of figures that you have picked up from the liquidity profile.

[Jamie Rollo, Analyst at Morgan Stanley]

Thanks. Should we be thinking about any sort of big exceptionals, if you're going to make some big redundancies, in this year or even next year? Thank you.

[Karen Witts, CFO at Compass Group]

I think-

[Dominic Blakemore, Group CEO at Compass Group]

Again, Sorry, Karen, do you want to take that?

[Karen Witts, CFO at Compass Group]

No, you carry on.

[Dominic Blakemore, Group CEO at Compass Group]

I was going to say, look, in the past, as you know, we've always right-sized the business when we consider it appropriate to the volume trends that we're seeing. We're obviously going to have a clearer line of sight of how the sectors are recovering, and what the pace of recovery is. Look, we also recognize we've got half of our workforce furloughed today. 10% of those are on government furlough programs around the world. Inevitably that will be phased out at some time, and maybe phased out before volumes recover. We just have to be poised to do the right thing and part of our planning is to ensure that we're able to do that. Those plans certainly wouldn't in any way be crystallizing that.

[Jamie Rollo, Analyst at Morgan Stanley]

Okay. Thank you very much.

[Operator]

We will now take our next question from Jaafar Mestari from Exane BNP. Please go ahead.

[Jaafar Mestari, Analyst at Exane BNP]

Hi. Good morning, everyone. Three questions for me, please. The first one, going back to the equity raise and the rationale. You've talked about why equity. Can you maybe help us understand how you calibrated the amounts, GBP 2 billion? What is this expected to cover in terms of duration, and what's the budgeting assumption, in terms of the rest of all your 2020 that you're trying to make sure you're well capitalized for? Second question, I appreciate it's very early days, but could you please comment on the first few weeks of reopening where it's happened? Maybe on the first full week of reopening in France, for example, how are clients behaving in offices, in manufacturing and in education? Lastly, just in terms of your product and your commercial strategy, what are the changes that you're making, if any?

[Jaafar Mestari, Analyst at Exane BNP]

What are you pitching to your clients for H2 2020 and for 2021 in terms of service levels, frequency, opening hours, mix of services? Is facility management and cleaning doing a comeback in some of your pitches?

[Dominic Blakemore, Group CEO at Compass Group]

Thank you, Jaafar. If I take the second and third question, then Karen can close on the first. In terms of the first few weeks of reopening, we've obviously had experience in China. China is a small market for us. Broadly, I think we all think China is around three months ahead of the rest of us. We've got about 95% of our B&I sites open with around 70% volumes, and education is yet to reopen there. There are sector differences between countries. With regards to our business there, it is non-urban, typically and more in manufacturing. Of course, the behaviors of authorities there are different in terms of the mandate to get employees back to work as quickly as possible. Also the speed with which they've adapted health and safety protocols to that new environment through past experience in particular.

[Dominic Blakemore, Group CEO at Compass Group]

We have seen sites open and close. We've also seen and learned a lot around temperature testing, around the hygiene, health, and safety protocols that need to be adapted, and how we can live with social distancing in the kitchen in a restaurant environment. We've therefore taken those experiences and developed best practices and processes that we shared around the world and with our teams, and that's enabled us to prepare for reopening elsewhere, where we can work as a strategic advisor to our clients by sharing those learnings. In terms of what we're seeing in some of the European countries right now, I think the first thing to say is it's very slow and steady. Where B&I has reopened in France, we're seeing 15%, 20% of volumes returning to work, no more at this point.

[Dominic Blakemore, Group CEO at Compass Group]

It's probably fair to say that in China, it ramps up over a number of weeks and months as well. It's flattened out at the 70% level. We're obviously recognizing the challenges of social distancing in the different environments. We're seeing manufacturers talk more about multiple shifts with lower workforce. Of course, that means that we need to be able to provide different day meal solutions during the course of the day, rather than more congregating around breakfast and lunch, so we have to adapt there. Moving on to your third question about sort of products and commercial strategy. Look, it's still very early days. We do talk in the presentation this morning of some of the trends that we're initially seeing. We see clearly a real value for health, safety, and hygiene protocols. That means the PPE equipment that our employees are provided with.

[Dominic Blakemore, Group CEO at Compass Group]

It means the protective screens that we've got, it means the safe social distancing to dine. Importantly, it also means how we create environments that don't feel alien, but feel comfortable. We're working with a lot of our clients at the moment as that how that can be achieved. I think the second is there is a strong belief that the health and wellness agenda continues to be very important, both in terms of the mental and physical wellness of employees in the workplace and at home. That's something which we already believe we have strong capability in with our sort of food science and nutritional teams, and we're working very hard there. Finally, we do believe there's going to be an acceleration in digital.

[Dominic Blakemore, Group CEO at Compass Group]

We will see every client is asking for cashless, pre-order, prepaid to queue bust, desk drop, grab and go, click and collect, anything which takes the sorts of the congregation of people out of the system, and more personalized meals on a one-to-one basis as opposed to the buffet offers that we've seen before. We think that digital has got a strong role to play in that. All of these things are how we will adapt our offer to a potentially lower volume environment in the short term as we all adapt to social distancing. Then I think will give us an opportunity in the medium term. Karen, do you want to take the point around the equity raise?

[Karen Witts, CFO at Compass Group]

The equity rationale, you wanted to hear a bit about calibration amounts and duration. The equity raise is part of a package of measures, Dominic's already talked about those. We've already taken cost savings, reducing our CapEx in the second half of this year, pausing acquisitions, suspending dividends, improving the liquidity position through an additional RCF. What the way we're trying to think about this is that we want to strengthen liquidity, we want to lower leverage, we want to continue to invest in the business. The GBP 2 billion is the amount that drops out of that once you've thought about your liquidity position getting back to or getting to a leverage range within a reasonable timescale of 1 to 1.5 times. As I said, continuing to invest in the business.

[Karen Witts, CFO at Compass Group]

We clearly, in terms of duration of the pandemic, just nobody knows. This is a very uncertain environment. When you're looking at these things, you have to take a critically sort of conservative planning view when you're thinking about liquidity and leverage.

[Jaafar Mestari, Analyst at Exane BNP]

Thank you very much for this. I get that was precisely my question. Thanks. I guess in budgeting and coming to the GBP 2 billion number because of the uncertainty, have you used your best estimates and a fairly granular recovery scenario, or is there an element of a worst-case approach in your calibration? Let's assume we stay at -45, that's the number that will definitely cover it.

[Dominic Blakemore, Group CEO at Compass Group]

You've asked Dominic. Look, we've looked at a whole range of scenarios. I think Karen put it very well when she said, look, our responsibility as a management team is to be prudent and conservative. We have looked through what some of those worst cases can look like, and then we obviously have to plan for that. At this point in time, it's impossible to budget, isn't it? We have no idea when sports and leisure will reopen. We have no granularity on what the education calendar and attendances will look like and the pace of recovery of B&I volume. We've had to look at a range of scenarios. What we are absolutely committed to is that we will pull every lever available to us to deliver profitable outcomes on the different volume scenarios. Over time, volumes will recover and our profitability will recover.

[Jaafar Mestari, Analyst at Exane BNP]

Thank you very much.

[Operator]

We will now take our next question from Vicki Stern from Barclays. Please go ahead.

[Vicki Stern, Analyst at Barclays]

Hi, morning. Just firstly, coming back on the volume outlook, I suppose, as we look into next year. You talked about China operating now at about 70% of prior levels. That gives a sense on the volume recovery there. Just any discussion around the price mix impact as we think about just total revenue for you? I suppose the offer that now needs to be provided potentially comes with a quite different price point. Secondly, just coming back to the working from home. I appreciate, obviously, quite early days. Just curious what you're hearing, though, from your clients already on it, in the discussions you're having. Is it, in terms of exposure, if you can give any sense as to sort of what proportion of B&I you think is sort of potentially exposed to that theme?

[Vicki Stern, Analyst at Barclays]

Also, do you see that theme in any way touching other segments outside of B&I?

[Dominic Blakemore, Group CEO at Compass Group]

Thanks, Vicki. Thank you. Good morning. Look, on the subject of price mix, clearly, we've got a few things going on here, haven't we? That there are additional costs to provide these services. We know that in PPE, in hygiene, in packaging, it's a different meal offer. I think our clients thus far are recognizing that that's absolutely the case and absolutely essential and necessary if they're going to safely bring employees back into the workplace. We're having positive conversations about the cost structure. Obviously within that also is the deleverage impact of volume.

[Dominic Blakemore, Group CEO at Compass Group]

We've got to be very thoughtful about how we recover our costs with appropriate contracts, and we're having those conversations with our clients, and we'll seek to put protections in place in our business in the short term and on renewals and new business which cater to this new environment, as it were. Look, there's a lot going on there. We're very focused on it, and absolutely what I believe is the next 18 months is about relentless operational focus to drive both the cost savings and also that price recovery that you describe. Look, on the second point about working from home, we do believe that there are very different trends by sector, by geography, by urban and non-urban area, and so forth. We don't think this is one-dimensional in any way.

[Dominic Blakemore, Group CEO at Compass Group]

With regard to industry, the conversations with our clients are absolutely that they need to get their workforce back in the workplace. This isn't about working from home in a manufacturing environment, of course. We do believe that we'll see that. That's 40% of our B&I sector. 60% is really the business elements of that. Again, there will be a split between major city and outside and the ease with which people can get to the office without using major transit systems. I think that's also a limiting factor.

[Dominic Blakemore, Group CEO at Compass Group]

When I've talked to clients, and I've talked to a number of senior clients around the world and CEOs of our major companies, look, they recognize, I think everybody is recognizing there has been an efficiency and an ability to work effectively from home, but there's also been many limitations and the ability for people to socialize, congregate, create together, engage, remains incredibly important to their business models. What we're hearing come out of this is an ambition to have greater flexibility, but more structured. I believe that's important to us because at the moment, as you know, there is significant ad hoc home working, which means Wednesdays and Fridays can be at 40%-60% volumes, and other days, 70% or 80%.

[Dominic Blakemore, Group CEO at Compass Group]

What we believe will emerge over time is a more structured program where different teams work from home at different times, and so forth, which will give us the ability to plan better for those volumes, adjust our cost base accordingly, and ensure that we have the best offer for those office workers. Also, of course, we're discovering through this an opportunity to provide evening meal solutions, meal kits, next day lunch bags to home workers as they leave the office environment. Again, there's an awful lot going on, and I think we need to recognize that this may be a trend, and therefore, how do we respond to it positively?

[Vicki Stern, Analyst at Barclays]

Okay, thank you. Sorry, is it a trend that in any way touches any of the other segments? I'm thinking higher education and.

[Dominic Blakemore, Group CEO at Compass Group]

Yeah, sorry, Vicki, I didn't pick up on that. Look, for obvious reasons, we don't believe it impacts any of the other sectors bar education. That would be higher ed. Look, we have seen remote learning. Remote learning has been a solution to the need not to be on campus in the short term. Again, I've talked to senior education leaders. There's a recognition of the importance of societal contact and individual development. Therefore, they're keen to have a balance where students are on campus and maybe social distancing and density is dealt with through a mix of lecture attendance and online lectures. I think we'll see a number of things come out of this. We're just going to have to course correct as we go.

[Vicki Stern, Analyst at Barclays]

Okay, thanks.

[Operator]

We will now take our next question from Daria Fomina from Goldman Sachs. Please go ahead.

[Daria Fomina, Analyst at Goldman Sachs]

Yes, hello. Thank you so much. I'm going to ask my first question on universities as we just finished that topic. We are in some renegotiating for the next year. Can you talk a little bit about how that conversation is going? A lot of the universities are under distress. How you expect that season to evolve for the 2021 revenues and contracts. My second question will be on the cost split. Obviously you guided and sorry if I missed it, my line dropped two times. You guided for GBP 150 million savings, now it's GBP 500 million. Can you give it a bit of a split of whether there's a part of it is government support and how big exactly that is so we can think through the impact when that unwinds?

[Daria Fomina, Analyst at Goldman Sachs]

My last question is on market share gains, as you mentioned, and the growth outperformance on the back of first-time outsourcing. Is there any way for you to quantify that benefit and the level of interest that you're seeing now as we're going through this distressed April and May month? Thank you.

[Dominic Blakemore, Group CEO at Compass Group]

Sorry, I missed. Would you mind repeating your first question? I missed that one.

[Daria Fomina, Analyst at Goldman Sachs]

Sure. It's on the universities or education, rather, renegotiation season for 2021. How is that going and how you see that shaping up as the summer months are very important, and whether you see a risk of a dramatic reduction, as a lot of universities are under, or some of the universities, under financial distress themselves?

[Dominic Blakemore, Group CEO at Compass Group]

Thank you. Sorry. Why don't I take the first and third questions and then Karen takes the second. Look, on higher ed in universities, I think I should make the point more broadly. We've continued to win new business and retain business even through the crisis. We've seen that in all of the sectors. Of course, we've been very thoughtful on any terms of business that have absolutely the protections we need as we go forward. We've had positive renegotiations where necessary, but I think you make a good point. There will be a number of institutions through this which will be stressed. They may be in sports and leisure, they may be in higher ed, they may be in healthcare. We're going to have to see how that also unwinds and impacts the business.

[Dominic Blakemore, Group CEO at Compass Group]

I think this is analogous in many ways to post the global financial crisis. We can talk a lot about how social distancing is impacting the business consumer client environment. We're also going to have to recognize that we may have volume pressure from exactly what you describe. Again, that's what we're going to have to address as we go through managing our cost base and selective management of clients. When it comes to market share gains and first-time outsourcing, again, what grounds us is the period after the global financial crisis. We saw an acceleration then in first-time outsourcing as institutions sought cost savings. We believe this will now be about cost savings and great health and safety protocols, which we believe we will be able to play into.

[Dominic Blakemore, Group CEO at Compass Group]

Therefore, we think it's critical that we continue to invest in the capabilities which will allow us to win those opportunities. In terms of share gains, look, we've already got examples of competitors who are unable to operate at all in this environment, and therefore business that they were mobilizing has come to us to start and take forward. We do know that there will be both of those opportunities. I think we have to look at our net new and make the right decisions to ensure we have the right contracts to exploit that opportunity, and then work really, really hard on the volumes to ensure that we're getting the right profitability profile in that new volume environment. Karen, do you want to pick up on the cost savings?

[Karen Witts, CFO at Compass Group]

On the cost savings? Yes. As you can imagine, we've been working really hard and really fast on the cost mitigation. So far we've got cost mitigations of about GBP 500 million per month. They come from a combination of reductions in our in-unit labor. That includes some overtime contractors, temporary workers, as well as government support schemes. We're also reducing salary. People are on reduced hours in our above-unit overhead level. We've also reduced our in-unit overheads, things like rents, rates, and concession fees. You're right, the number has increased as we have given our updates through in April. We said we had cost mitigations of GBP 450 million, now we're saying GBP 500 million. In March, sorry, GBP 450 million, in April we're saying GBP 500 million. The distance between the two has come partly but not fully from the government support kicking in.

[Karen Witts, CFO at Compass Group]

With 50% of our business currently suspended, we have furloughed about 50% of our workforce. 13% of our workforce is receiving some form of government support. The government support mostly comes from continental Europe and the U.K. There's very little in North America, and there's none in Latin America. Every country has a different scheme, different duration, different contribution to the support. It's very complicated to work through. Just to emphasize again, when we're thinking about this from a cost-saving perspective, it's not that these support schemes cover 100% of the cost. They make a contribution to the cost.

[Daria Fomina, Analyst at Goldman Sachs]

Thank you.

[Operator]

We will now take our next question from George Weston from UBS. Please go ahead.

[George Weston, Analyst at UBS]

Good morning, everyone. Three as well. Can you maybe just talk a bit about where you were in terms of perm versus temp mix across the organization, and how you see that evolving now going forward, given, I guess, you'll need more flexibility, not less. Secondly, you've put M&A on hold. What about disposals, and indeed, will you be looking to scale them back or maybe accelerate some disposals? You touched on, I guess, a little bit on pipeline, but can you just give a bit of additional color in terms of has the pipeline itself shrunk? Are there indications of growth? Any kind of forward indications on client churn as you went from March to April to May would be interesting if you could give some color there. Thanks.

[Dominic Blakemore, Group CEO at Compass Group]

Sure. If I let Karen take the perm versus temp question, I'll do the other two. Look, we've put all M&A on hold, as you would expect. Anyone who was in any discussions with us has also paused their processes. Just in terms of sales pipeline. Look, we had a very exciting pipeline in many of our markets coming into this. Some processes have continued to run, others have been put on hold, and actually some have been accelerated to a positive outcome. On retention, we've also seen a significant opportunity to extend business and retain business through accelerated processes. Again, I think it's a good example of clients wanting resilient partners. Look, I think we have definitely seen a pause. It's been difficult for people to work through these processes virtually and online.

[Dominic Blakemore, Group CEO at Compass Group]

There has been a continuation, and the indications continue to be broadly positive.

[Karen Witts, CFO at Compass Group]

If I just pick up on the perm v temp question, George. Temporary labor is about 12%-13% of the global workforce. The extent of flexibility in our labor model is partly a function of the labor law environment by country, by region. We have a very flexible model in North America. Clearly, labor laws in Europe in particular are a bit less flexible. We are always looking at ways to make the way that we deploy labor more efficient and more effective. Clearly, given the current situation, we're going to have to think even harder about that.

[George Weston, Analyst at UBS]

Okay. Thanks very much.

[Operator]

We will now take our next question from Kean Marden from Jefferies. Please go ahead.

[Kean Marden, Analyst at Jefferies]

Morning, all. I've got a few more questions on unit economics, if you don't mind. I think I've read some reports recently suggesting that sites would require a dedicated sanitation employee. Is that something that you agree with, or do you think that those tasks can be conducted by the existing workforce, and therefore you don't necessarily need to run with additional headcount in unit? Interested in your comments on positive discussion with clients just on those. Does that relate to upfront CapEx that might be required in the business? Kiosks, trollies, additional serving, shelving, and does that relate to OpEx as well? Whether there's a distinction between the two. I'm also interested in whether those comments also apply to your fixed price contracts that you have in the portfolio as well.

[Kean Marden, Analyst at Jefferies]

Finally, could you maybe just provide some insight into what does the in-unit margin look like in China if you're operating at 70% of previous revenue? Are you still profitable at that level or not?

[Dominic Blakemore, Group CEO at Compass Group]

Kean, there's a lot of detailed questions in there. Let's just try and pull a few apart. Look, when it comes to your comment about sanitation workers on site. Look, what we're doing is two things. We're working with public health authorities in the countries in which we operate, as well as our clients, to ensure that we've got processes and protocols that meet minimum local country standards, and they will be different for us everywhere. Then also, we have a conversation with our clients about what best practice looks like. Of course, that also includes disinfection hygiene services and potentially dedicated workers for that where we have the capabilities. We actually see that as an opportunity for, again, differentiation and also value creation because these services are essential and critical. When it comes to the client conversations, look, you're absolutely right.

[Dominic Blakemore, Group CEO at Compass Group]

There's a differentiation between OpEx around additional costs to serve in this environment and CapEx, which is about ensuring the environment is appropriate as we go forward. They're all individual conversations. I think clients recognize, again, the criticality of having the right environment and the right services, and that that has a different cost profile, and that's exactly what we're discussing with many of them today to ensure that we protect our own commercial terms and recover those costs. There are a number of ongoing conversations, of course, about how we move to trading terms with our clients that protect us and provide these services, which I really do believe they're valuing at the moment.

[Dominic Blakemore, Group CEO at Compass Group]

Remember, a third of our book is cost-plus contracts, which allows us to recover that. You're absolutely right to point to fixed price, where we've got unitary economics, which are based on volume and leverage. That's where we're working very hard to put protections in place, both in terms of volume allowances, but also reversion to cost-plus, particularly through the reopening phase, where putting these new measures in place is more costly. Look, all I can say in China is, as we all learn everywhere, it's a journey. Our ability to restore unit margin to its former levels will be based on three things. First of all, our ability to manage cost to that new volume environment. Secondly, our ability to recover exactly the new costs that you've described. Thirdly, as those volumes restore.

[Dominic Blakemore, Group CEO at Compass Group]

Look, I can't call the margin in China right now, but I do recognize that this will be a journey for us over time, and we're working very hard on that.

[Kean Marden, Analyst at Jefferies]

Right. Apologies for the detailed questions, but that was really helpful. Thanks again.

[Operator]

We will now take our next question from Stuart Gordon from Berenberg. Please go ahead.

[Stuart Gordon, Analyst at Berenberg]

Yeah, good morning. A couple of questions here. You've mentioned significant reverse inquiry from some companies out there, for you coming in to step in and offering services. Are you also getting reverse inquiry from some competitors who are financially distressed and looking to come under the Compass umbrella? If so, how will you adapt the sort of suspension on M&A, if some of that is interesting? Secondly, under reverse inquiry, both elements, I assume that that's excluded from the sort of sensitivity, which I appreciate is not in any way guidance, but the sensitivity chart that you show in the presentation today.

[Dominic Blakemore, Group CEO at Compass Group]

Yes. Thank you, George. Yeah, absolutely. Again, just to stress, those sensitivity charts are illustrative and stress test. Yes, they are volume profile and not net new business, as it were. With regard to the reverse inquiries, we've closed a number already, as I said earlier. Interesting, yes, you are right. There are others in the industry that are considering their futures. Of course, we need to be very careful not to inherit bad books of business, but there are different ways of working with people than simply traditional M&A.

[Stuart Gordon, Analyst at Berenberg]

Thank you.

[Operator]

We will take our next question from Peter Testa, from One Investments. Please go ahead.

[Peter Testa, Analyst at One Investments]

Hi, a couple of questions, please. I was wondering on the sites that you have which are open, where you've basically put in health and safety and so on, and you've also started to adapt menus. Can you give any sort of sense as to how the total cost of service, including menu simplification and maybe extra labor is working as you've had to stretch hours and so on? The second question is, as you mentioned, there's not all the furloughed labor costs are covered by governments. Can you give some sort of sense as to how much your cost of furlough is at the moment within that GBP 500 savings, what the gross number, including the fact that you're having to pay part of furloughed staff costs at a period when you're shut?

[Peter Testa, Analyst at One Investments]

The third thing is, you talked a bit about the opportunity on retention being potentially better in the short term and sales obviously a bit more challenging. Can you give any sort of sense of how the net changes versus a normal Compass flow on that front?

[Dominic Blakemore, Group CEO at Compass Group]

I guess, with a number of the questions we received and your questions now, Peter, you're asking for a degree of precision, which is incredibly hard for us to give eight weeks into this crisis with so many changing dynamics. I'd ask you all to just reflect on that as well. We can give you mood music and trends at the moment, but I think we have to just respect that. Look, we're working really hard. In the first instance, your first question on site openings, we're working really hard to do everything our client needs and wants, and we believe that's what will create the goodwill for us to be able to recover those additional costs and services and to have thoughtful and sensible renegotiations.

[Dominic Blakemore, Group CEO at Compass Group]

As you would expect, I think we've managed costs as well as anybody in our industry, and we will continue to do that. I'll just ask Karen, in a second, to comment on the furlough point. Again, with regard to retention and sales, it's just too early to tell. We're seeing, I wouldn't say a dramatic change in either immediately, but it's very difficult to tell when we've had eight weeks of these types of working conditions. Look, I think we'll have better views on that as we get to quarter three and beyond. I think to the point, though, we all need to track the evolution of net new and the evolution of volume separately. Winning on net new will be about the long-term health of the business.

[Dominic Blakemore, Group CEO at Compass Group]

Recovering volume will be about protecting our profitability, and the two are exactly what we're focused on as a management team. Karen, the furlough question?

[Karen Witts, CFO at Compass Group]

Yeah. I think you commented on it, Dominic. Things do change all the time. Just to give you an example of the kind of change that we see, up until about 10 days ago, the U.K. government was covering about 80% of the cost of employees who had been furloughed up to the end of June. They've now extended the timeframe and reduced the support. Each country, as I've said, is very different, ranging from about 60% being covered right up to 100% being covered. I think maybe another way of looking at it is to say we've got 50% of our workforce who are working and 50% who are not. The ones who are not are funded by a combination of government support. Some of them are client-paid.

[Karen Witts, CFO at Compass Group]

More typically, in the U.S., after a very short period of time, people don't get paid when they're on furlough.

[Peter Testa, Analyst at One Investments]

Right. Okay. Is CapEx going to change a lot going forward, do you think?

[Dominic Blakemore, Group CEO at Compass Group]

Karen, do you want to take that?

[Karen Witts, CFO at Compass Group]

I think, again, we just need to wait and see. I think we feel that rather than necessarily changing a lot in percentage of revenue terms, and clearly the quantum will depend on maybe what our revenue is, if we want to keep that sort of metric, we actually think that the CapEx may look a bit different. Up until now, we've had CapEx focused on sports and leisure, focused on education. We actually think that there is an ongoing place for CapEx more in the digital space and in terms of adapting kitchens and dining rooms to new health and hygiene requirements for social distancing.

[Peter Testa, Analyst at One Investments]

Great. Thank you very much for the help. Thank you.

[Operator]

We will now take our next question from Richard Clarke from Bernstein. Please go ahead.

[Richard Clarke, Analyst at Bernstein]

Good morning. Thanks for taking my questions. Three, if I may. The company presentation you put out today specifically mentions inorganic growth opportunities. Presumably these are over a longer period of time, but if you could comment on maybe where you might see inorganic growth opportunities. Are these going to be distressed competitors or more technology players? Second question is, your goodwill balance seems to have survived this. If you could just comment on the nature of no necessity to take any impairments and the decisions on not impairing that goodwill balance. Lastly, just on Europe, margin down 170 basis points. My rough estimate is that means the drop-through there was somewhere in the sort of high 40s, which is quite a bit higher than obviously you were showing for Europe drop-throughs last year. Just any comment on what's happened in Europe?

[Richard Clarke, Analyst at Bernstein]

Why is the margin down so much there?

[Dominic Blakemore, Group CEO at Compass Group]

Yeah. Let me take the first question, and then if Karen could pick up on goodwill and Europe. Look, yes, we talk about inorganic growth. Obviously, that is an opportunity that we believe will be there in the medium term. Look, we believe healthcare is a sector of great opportunity, will be better recognized and valued as we go forward, as well as aged care. There's a significant self-op opportunity within that space. We will look at sectors when we're considering this, yet we do believe also there may be fresh business opportunities. Finally, I agree, capability requirement may be different. You may have seen our Feedr acquisition before the COVID crisis in London, which gives us the capability to have online delivery to SMEs across London where they wouldn't typically have on-site catering. I think there are a number of things at play there.

[Dominic Blakemore, Group CEO at Compass Group]

We've always participated in infill M&A, and we'll obviously be circumspect and very thoughtful about returns in this environment. Absolutely, I want to stress again, this 18 months is about relentless operational focus as we see volumes recover and as we restore the profitability.

[Karen Witts, CFO at Compass Group]

Richard, I wasn't sure if I heard you correctly. Was your question why have we not had any goodwill impairments in the half year?

[Richard Clarke, Analyst at Bernstein]

Yes, that was one question, yeah, whether there was any or would there be any necessity to impair any of that goodwill.

[Karen Witts, CFO at Compass Group]

Oh, got you.

[Richard Clarke, Analyst at Bernstein]

Then the second question was just on the Europe margin performance, down 170 basis points. Looks like a big drop-through in Europe. Any commentary there?

[Karen Witts, CFO at Compass Group]

Let me pick up the goodwill question first then. The short answer is that we have sufficient headroom across all our countries and regions. In actual fact, you look at headroom in terms of long-term cash flow, you'd be surprised if you saw anything in a phenomenon that so far has only lasted eight weeks. Technically, we've got sufficient headroom everywhere. In terms of the Europe drop-through, actually, we did make progress between the end of March and the end of April. When I spoke about the cost mitigations increasing from GBP 450 million to GBP 500 million, that was between March and April. In March, the impact of COVID was over a two-week period, that's quite hard to mobilize your cost reduction in that period.

[Karen Witts, CFO at Compass Group]

By April, the drop-through had decreased quite significantly, and that was the contributor actually to the overall drop-through from the 28.5% to 22%.

[Richard Clarke, Analyst at Bernstein]

Maybe if I could just ask one quick follow-up, just because you brought up Feedr there, Dominic. Feedr is actually delivering to home. I think part of its offer is it does say it can facilitate working from home. Is this something realistically Compass could ever do at scale? Is this just something for the moment that's happening right now?

[Dominic Blakemore, Group CEO at Compass Group]

Look, I think with a lot of digital, it's about experimentation, isn't it? What we like about it is the capability to deliver into SME. We believe that there's an opportunity to deliver different solutions into our existing client base. We do believe potentially that the home worker could become a target consumer, and therefore, any route to target those individuals could be positive. We've just got to suck it and see, haven't we, as we go.

[Richard Clarke, Analyst at Bernstein]

Thanks very much.

[Dominic Blakemore, Group CEO at Compass Group]

Thank you. Can I ask for maybe one last question, and we'll close the call?

[Operator]

Please allow me to take our final question from Rowan Dartington from Rathbone Brothers. Please go ahead.

[Rowan Dartington, Analyst at Rathbone Brothers]

Hi, guys. I'm afraid it's back on the placing again. We're at what is probably the trough. You guys are burning GBP 100 million-GBP 150 million cash per month. You got GBP 3 billion liquidity, that's 20-month plus run rate. You don't have big debt balloon payments. Walk me through in what scenario do you really need that GBP 2 billion?

[Dominic Blakemore, Group CEO at Compass Group]

Look, I don't think any of us have got the ability to predict troughs. Look, we have considered a number of different scenarios. We've taken what we believe are responsible actions as a board to conservatively plan for those and take all the actions necessary. As you've heard us say today, we will have an elevated EBITDA to net debt leverage ratio for some time as we navigate our way through recovery. Our desire is to flatten that particular curve as quickly as possible and restore our historic leverage while continuing to invest in the business. Therefore, we believe it's appropriate to be on the front foot, take actions quickly, and to do so ahead of any prolonged uncertainty.

[Analyst at Rathbone Brothers]

I can see where you're coming from. I'm not convinced it's a good reason to raise a large part of your market cap at a depressed price.

[Dominic Blakemore, Group CEO at Compass Group]

Well, thank you for the question. I think we will now move to close the call, and specifically with regard to the placing. We spoke to many of our investors in the days ahead of launching the deal, and I am pleased to say that the book is now formally covered. Thank you all very much for your questions today and your contributions, and we look forward to speaking to you after the third quarter results.

Participants

Executives

• Dominic Blakemore, Group CEO
• Karen Witts, CFO

Analysts

• Daria Fomina, Analyst at Goldman Sachs
• George Weston, Analyst at UBS
• Jaafar Mestari, Analyst at Exane BNP
• Jamie Rollo, Analyst at Morgan Stanley
• Kean Marden, Analyst at Jefferies
• Peter Testa, Analyst at One Investments
• Richard Clarke, Analyst at Bernstein
• Rowan Dartington, Analyst at Rathbone Brothers
• Stuart Gordon, Analyst at Berenberg
• Vicki Stern, Analyst at Barclays
• Analyst at Rathbone Brothers