Sodexo - Limited Upside Potential

| About: SODEXO (SDXOF)

Summary

Catering companies provide services to clients on a contract of a 5 years or more basis. Compass Group PLC and Sodexo are the biggest companies competing on a global scale.

The demand for outsourcing of catering services will continue to grow because many companies and public bodies are outsourcing their non-core businesses to companies such as Sodexo.

The current valuation is in line with 5 year average.

In this article, I would like to have a look at the companies that provide catering services to business and industrial clients, educational institutions, healthcare and medical facilities, sports, leisure and tourism, defense, prisons, and offshore oil rigs. These services are provided on a contract of a 5 years or more basis. The catering services industry is dominated by two big players - France's Sodexo and the UK's Compass Group PLC, with other companies being significantly smaller.

On July 8, 2016, Sodexo (OTC:SDXOF) reported the results for the nine months, revenue being €15.7 billion, up by 3.7%, with organic revenue growth contributing 3.3%. The organic growth of onsite services was 3.2%, while the benefits and rewards services was up by 5.7%. The performances in geographic locations were different: The United Kingdom and Ireland had the biggest organic growth of 18%, and mainly driven by the Rugby World Cup; North America was up by 4%; Europe was up by 1.8%, while the rest of the world was down by 3.9%.

Sodexo is the French company that provides on-site services, benefits and rewards services, and personal and home care services. In simple words, the company offers all kinds of services that large enterprises or public bodies want or need to outsource, from construction management to reception to medical equipment sterilization to housekeeping to technical maintenance to leisure cruises and from food services to prisoner rehabilitation. The company has a very broad range of customers in different areas, including defense, justice services, healthcare, seniors, and education. Such well-known companies as Airbus, AstraZeneca, Banco Santander, Coca-Cola Enterprises, Johnson and Johnson, Procter and Gamble, the U.S. Air Force, and Space Center Houston are among Sodexo's clients. The company is one of the biggest employers in the world, with approximately 420,000 employees on its payroll. The Sodexo founders' holding company, Bellon SA, owns 37.7% of Sodexo's capital and 51.8% of the voting rights, thus controlling the strategic decisions taken by the firm.

The revenue by geographic region is provided in the chart below. It should be noted the company has very equal exposure to different regions.

Sodexo has a strong presence outside of France. In reality, very few businesses compete with Sodexo on a global scale. Sodexo's market shares (source IBISWorld) in the U.S. and the U.K. is provided below.

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Stock performance

Analyzing the performance of the stock since July 2011, it should be noted that the stock price grew from €54.20 on 22 July 2011 to €101.85 on 22 July 2016 at the compounded growth rate of 13.4%.

Valuation

The current price to earnings ratio is 21.7, which is in line with the 5-year average of 21.6. The biggest competitor - Compass Group PLC - has a price to earnings ratio of 26.6.

The stock's attractiveness is evaluated using a simple method. The estimates for three future years are taken and then multiplied by the P/E ratio for the stock that it is believed to be in the market for the particular stock in question. To simplify the calculations, the P/E ratios of the past five years are used: the minimum and the average of the previous five years, and compared with the average for the industry. Only if the estimated stock price implies the 15% annual return, the stock is considered for investment.

According to the FactSet database, the estimated EPS for calendar years 2015-2018 is as follows (in €):

2015

2016

2017

2018

EPS estimate

4.53

4.67

5.1

5.73

EPS growth rate

3.1%

9.2%

12.4%

Stock price using min P/E of 5 years (16.5x)

77.06

84.15

94.55

Stock price using average P/E of 5 years (21.6x)

100.87

110.16

123.77

Implied annual return

-2.2%

5.6%

8.3%

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EPS estimates:

Conclusion

Sodexo has benefited from and continues to take advantage of the trend that many private companies, wanting to become more efficient and cope with increased competition, are outsourcing their non-core businesses to companies such as Sodexo, as well as the current trend to cut public expenditures in the U.S., U.K., and other countries. There is no doubt that demand for outsourcing of catering services will continue to grow. When the price of service is the primary factor for outsourcing the catering services, the big players, having the scale and ability to provide integrated services, will take the biggest share of the pie. However, there are some risks. Sodexo employees receive the salary that is at the bottom of the pay level in the economy. The trend to increase the minimum wages in different countries could bite into Sodexo's bottom line because it is not clear whether the company will be able to pass on the higher costs until the existing contract expires.

There is also the issue of the customers being willing to eat healthier food. Thus, the company has to adopt and provide food that is not only cheap but also healthier than before.

After the current stock run from €88 to €101 since the beginning of May, Sodexo has very limited upside potential. The stock price needs to drop to a level of €90 (i.e. 12% below the current price) to be considered suitable for investment and to yield an annual return of 15%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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