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Compass Group points north

Last updated: 20:47 19 Feb 2009 AEDT, First published: 21:47 19 Feb 2009 AEDT

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…However, in June 2006 Richard Cousins took over as Chief Executive and embarked upon a significant restructuring program.  Many underperforming overseas operations were sold and the group has refocused on its core competence of contract catering.

The FTSE 100 battles to stay above 4000…


As can be seen from the above chart of the FTSE 100 the selling experienced this week created an air of panic among investors, as the index declined over 200 points within a few days.

Passing of the US fiscal stimulus package failed to allay market jitters, as signs of a faster than expected deterioration in the health of the global economy dominated investors pessimism. Fresh concerns over emerging markets and central and eastern European economies (CEE) have weighed on Western banks with large exposures to these regions.

Technical analysis of the above chart shows that initial support from the medium term upward trend line has been broken and that the index is desperately trying to hold on to the important historical and psychological 4000 level. The FTSE has traded below 4000 intraday on several occasions, although it has not closed below this level since the end of November, which is significant. It is also worth noting that the relative strength index (RSI) is currently higher than it was when the index was trading at similar levels back in January, which suggests that there is less selling momentum behind the recent falls.

In summary, the FTSE is currently trading at very significant levels and a conclusive break of 4000, which could be indicated by the index closing below 4000, may initiate a re-test of the October lows at 3700. However, until the technicals are proved wrong I am going to suggest that 4000 will hold and that the current levels are offering a very attractive risk/reward ratio.

As we could be nearing the lows on the FTSE I am going to continue focusing on sectors that have historically outperformed the market within the first year of a bull market. Travel and Leisure companies have beaten the wider market in the first year in seven of the last nine bull markets and have outpaced the index by an average of 18% on these occasions.

The largest stock by market capitalisation within this sector is Compass Group (epic: CPG), which is the worlds leading foodservice company supplying schools, hospitals, offices and leisure centers in 62 countries.

Compass released an upbeat trading statement on the 5th February, which indicated that they had experienced a very positive first quarter, with operating profit running well ahead of the same period last year.

The company has historically been held in poor regard, with a string of profit warnings causing the shares to underperform the wider market for an extended period.

However, in June 2006 Richard Cousins took over as Chief Executive and embarked upon a significant restructuring program.  Many underperforming overseas operations were sold and the group has refocused on its core competence of contract catering.

As a result, the flexibility of its cost base and improved cost efficiencies has enabled them to improve operating margins and increase profitability. In the first quarter, Compass reported (stripping out currency movements) that the groups operating profit is running well ahead of the same period last year.

The company also reports its profits in Sterling, but generates significant amounts of revenue outside the UK, with North America accounting for 40% of total revenue. In the first three months of the financial year the average $ and € exchange rates were 1.59 and 1.2 respectively, compared to 2.04 and 1.41 a year earlier. Resulting in an overall gain of £30 million onto the group’s first quarter operating profit, with further favorable moves seen recently.

There has inevitably been some weakness in like for like volumes in parts of the business in industry, sports and leisure divisions. Although, some significant new contract wins and strong retention rates in education, healthcare and other remote sites have created impressive levels of overall net new business.

Overall, this is a very positive statement from Compass and the chief executive has achieved an excellent turnaround at the company. The shares are trading on a forward earnings of 11x, which is cheap relative to their main rival Sodexo (French company). With further currency benefits, falling food prices and an ongoing significant share buy back this leads to a very interesting and defensive growth story for the market leader.


As can be seen from the above chart of Compass, it is apparent that the shares have held up well relative to the wider market over the past nine months. Since trading a double bottom in November 2008 the shares have responded positively to various trading updates and appear to be in a sideways trading range between 310/320p and 360p.

Recent market weakness has bought Compass down to the lower band of its recent range, which in my view represents an interesting short term trading opportunity. Furthermore, the stochastic is nearing the floor of its trading band and this has historically represented a good buying opportunity.

 


If we combine our earlier analysis of the FTSE with the strong fundamental and technical analysis on Compass, I am inclined to suggest that the shares could trade higher.

At the time of writing the share price is 319.5p and my short-term opinion is positive. Near term targets are seen at 332.5p, 344p and 358p. I shall place a stop loss on the trade marginally below recent support levels at 306.5p.






Mark Allen is Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Compass. The material in this report has come from Fidessa, Share Scope and Compass’s corporate website.  





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