Cautious recommendation for Compass

Apr 19 2010 by Andrew Miller, The Journal

Share Watch with Andrew Miller

COMPASS - We have upgraded our EPS forecasts for all three forecast years following another strong trading update. We have also raised our DCF derived fair value to 570p and reiterate our buy recommendation.

At a recent meeting, Compass’s management stressed that the recovery in cyclical volumes is likely to be slow. Given the high correlation between unemployment and cyclical catering volumes, we understand why management would be cautious.

However, our current forecasts for 2011 (+3.6% organic revenue growth) imply that cyclical volumes in that year only grow by 0.4% if all other components of growth (pricing, net new business, non-cyclical volumes) continue at the current pace. This compares with a decline of -6.5% in 2009 and our forecast of a further -4% in 2010.

While our economists remain cautious regarding a material decrease in UK and European unemployment rates, they are more positive regarding the US recovery and we see some upside risk to our cyclical volume forecasts, which tend to move in line with unemployment rates.

Informa – Following decent results, we are maintaining our buy recommendation and upgrading our fair value on Informa to 420p.

This is based on a sum of the parts valuation. Informa suffered during the global recession, due to the cyclical nature of its businesses and the high level of debt on its balance sheet. Following a rights issue in 2009, debt was paid down to manageable levels. As we progress through the economic cycle, we are expecting Informa’s cyclical operations to recover and would buy into the shares as we reach stabilisation.

Additionally, Informa’s markets are in the process of consolidating and here we expect some long-term opportunities for the company to improve its market share.

FirstGroup – We are retaining our buy recommendation on FirstGroup while revising our fair value estimate slightly higher to 439p which is now based on 2011E earnings.

The 2010 pre-close statement was disappointing, however we believe we are nearing the end of the downgrade cycle and think the shares offer a good mix of defensive revenues, while also geared for economic recovery.

In our view, a relatively high level of debt and a lack of momentum in the school buses business may continue to weigh on the shares over the short term.

However, while the timing has become more uncertain, we do expect the shares to re-rate, given the benefits from rail reform, solid UK bus performance, recovery in Greyhound and longer terms structural gains expected in the US bus business.

We therefore retain our buy recommendation in anticipation of a re-rating and the group remains our preferred pick amongst the UK bus and rail companies.

Andrew Miller is head of the Newcastle office of Barclays Wealth