OREANDA-NEWS. February 09, 2015. Fitch Ratings has affirmed UK-based food services company Compass Group PLC's (Compass) Long-term Issuer Default Rating (IDR) and senior unsecured ratings at 'A-'. The Outlook is Stable.

The affirmation reflects Fitch's expectation that Compass will continue to generate positive free cash flow (FCF) and maintain the steady growth seen over at least the past four years. The ratings also reflect the company's strong customer and geographic diversification and stable retention rate at above 90%. This is, however, balanced by a lack of leverage headroom mainly as a result of a return of GBP1bn cash to its shareholders in FY14. Fitch expects Compass's funds from operations (FFO)-adjusted gross leverage over FY15-FY16 to be around the 3.0x maximum threshold compatible with the current 'A-' rating. However, this is mitigated by Compass's proven ability to maintain strong cash generation and by Fitch's expectations that it will retain strong overall financial flexibility.

KEY RATING DRIVERS

No Leverage Headroom
The forecast increase in FFO leverage over FY15-FY16 to around 3.0x (FY14: 2.9x) is a result of Compass's debt issue to fund its share buyback programme and its GBP1bn cash return to shareholders in FY14. However, Fitch views positively Compass's maintenance of a leverage target of net debt-to-reported EBITDA of 1.5x, indicating its willingness to protect its credit metrics and ratings.

Shareholder Friendly Policy
Compass has over the last four years distributed more cash to shareholders through dividend and share buyback programmes than it generated in FCF. While Compass's cash flow remained stable at GBP663m-GBP731m (FCF before dividend) a year between FY11-FY14, shareholder distribution has resulted in its leverage being outside the range compatible with its 'A-' rating. However, Fitch estimates that FCF will be sufficient to fully cover Compass shareholder distributions from FY16 onwards.

Stable Business Profile
Compass benefits from its large size within the food service industry, a diversified customer base, a high contracted revenue base and strong geographical diversification. Compass has also demonstrated the ability to offset macro-driven operating pressures with a stable client-retention rate (93.5% in FY14), active management of its cost base and the development of its "soft" (non-food) support service offering.

Steady Cash Flow Performance
The ratings reflect continued growth and consistent positive FCF generation over at least the past four years. Fitch expects that FCF margin will continue to be in the range of 1.4% to 1.6% in FY15-FY16, supported by sustained profitability and low working capital and capital spending requirements. We also expect that the group will continue to expand through additional net new business wins and infill acquisitions as it focuses on organic growth.

Geographical Diversity
Compass's stable performance has been supported by its increasing presence in fast-growing emerging markets and strong new business wins in North America over at least the past four years. Organic sales in the fast-growing emerging markets and North America increased 8.1% and 6.8%, respectively, in FY14. In Europe and Japan, organic sales are declining, albeit at a slower rate, at 1.5% in FY14 compared with 3% in FY13.

RATING SENSITIVITIES

Negative: Future developments that could lead to a negative rating action include:
- Negative organic sales growth and significant EBITDA margin erosion
- Continuation of an aggressive financial policy or operational weakness leading to FFO- adjusted gross leverage deterioration above 3.0x on a sustained basis
- FFO fixed charge cover below 4.5x (FY14: 6.3x)
- Insufficient FCF (pre-dividends) from FY16 to fully cover shareholder returns

Fitch is unlikely to upgrade the ratings due to the low operating margin of the industry, Compass's modest FCF margin, and the asset-light nature of the business.