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Hugh Yarrow: how Compass navigated its way into my top stocks

Hugh Yarrow: how Compass navigated its way into my top stocks

Richard Cousins gave his last results presentation before retiring as chief executive of Compass Group in November.

I remember meeting Cousins several times many years ago when he was chief executive of the rather unpromising-sounding British Plaster Board plc (though, as the great investor Peter Lynch used to point out, some of the most successful investments have the least interesting names).

British Plaster Board was not endowed with the world’s strongest portfolio of franchises, but in his low-key way Cousins nevertheless got on with executing a sensible, consistent strategy that proved highly rewarding for patient shareholders.

It involved exiting the diverse set of businesses that British Plaster Board had ended up with to focus purely on investing consistently in the business in which it enjoyed a clear leadership position – yes, you guessed it: making plasterboard.

His tenure ended prematurely when the company received a hostile approach in 2005 and was taken over: his management style represents what I like to call ‘incrementalism’, a mindset that is far removed from such shenanigans.

At the time, when attempting to defend the company from the approach, he said of the process: 'I haven’t really enjoyed it. People like me are designed to run businesses, not campaigns like this.'

Finding his way at Compass

Cousins subsequently arrived at Compass in 2006, at a time when the company was failing to realise its potential operationally, and had lost its focus. Over subsequent years, a much more disciplined culture and management style has become deeply embedded within the company.

In the first few years with Cousins at the helm, Compass exited more than 40 difficult, sub-scale businesses and began to focus on its market leading geographies and brands, where the potential to generate high returns on invested capital and long-term growth were far more attractive.

Since then, disciplined incremental investment and bolt-on acquisitions have steadily expanded the company from these solid, market-leading foundations.

IBM’s founder Thomas Watson once said: 'I’m smart in spots and I stay around those spots.' To paraphrase Watson, it can be highly productive for long-term shareholders when a management team understands the spots it is smart in and stays close to them.

This has been the philosophy of Compass’ incrementalism strategy and its fruits have been plentiful. Free cash flow and dividend growth per share have averaged +13% and +12% per annum, respectively, over the last decade.

Part of the company’s discipline has also involved a recognition that sometimes surplus cash is best returned to shareholders. Since 2006, Compass has deployed significant self-generated cash flow into organic investments and bolt-on acquisitions.

However, the company has also returned £9 billion of excess cash to shareholders in the form of ordinary dividends, special dividends and share buy-backs. This is quite an achievement, particularly given the fact that the whole Compass business was worth less than £5 billion at the start of Cousin’s tenure.

Incrementalism in action

Other examples of Evenlode holdings pursuing a more incremental approach recently include, Smiths Group, Sage, Informa, UBM, Spectris, DMGT and Euromoney.

Under current management, all of these companies are investing consistently in areas of their respective portfolios that enjoy excellent leadership positions and good potential for growth; products and services that do not fit the bill are being de-emphasised or disposed.

At their results presentation last month, Informa was asked whether the recent investment programme into digital capability and new product innovation would be tailing off given new products are beginning to come to market. But as management put it: 'It’s not like we’re going to go through this programme and stop. It’s just the start of a cultural and operational change; we’re looking to continuously update products across the portfolio.'

This is ‘incrementalism’ in action.

It is true that some companies have inherently more attractive economics than others. At Evenlode, we spend much time thinking carefully about these characteristics and looking to identify them.

However, no business is simply made great and stays great. Like gardeners, management teams need to give even the best franchise consistent, on-going care. Knowing which bits of a company to water and which bits to prune is a very important part of their job.

We wish Cousins and other low-key, incrementalist stewards of shareholder capital well for the future: may they continue to stay around the spots they are smart in and stay close to them.

Hugh Yarrow is the Citywire AA-rated manager of the Evenlode Income fund. Over the last thre years the portfolio has returned 47%, versus a peer average of 30.1%.

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