Three companies finding light in economic darkness

  • Prospects look good for HSBC’s net interest margin
  • Is Pearson finally succeeding with its digital education strategy?
  • Compass Group well positioned for share price recovery

Rising interest rates, food price inflation and the pressures brought about by Covid would typically be seen as negatives. However, for two of our featured companies this week these factors are the opposite: in one case accelerating the reshaping of a core market and in the other pushing up returns on capital. For Compass outsourcing of food service provision is likely to be accelerated and for HSBC a widening net interest margin should finally push its returns above its cost of capital. Our third company, Pearson, finally looks to be proving that the wholesale repositioning of its business over the last 7 years is finally delivering results.

HSBC Holdings (HSBA) – rising interest rates are usually seen as a negative but not so for the UK’s large banks. The major swing factor is the NIM or net interest margin. This is where banks are increasing interest rates on loans but not passing this increase through to savers/depositors, who are still a major source of banks’ capital. This should allow HSBC’s return on equity, finally, to exceed its cost of capital which could allow the gap between the group’s book value and share price to narrow. However, all banks are in the same boat and others in the sector look to offer better upside on any closer alignment of share price and NAV.

Pearson (PSON) – Pearson, once a publishing giant and mini-conglomerate (of sorts) has spent the last 7 years trying to find itself. The transition to a digital education platform business has not been easy and has tested the patience of many investors. However, there are ever clearer signs that Pearson is finally beginning to deliver on its promises. Growth here looks decent but less than stellar, so a PE of 18.5x (against a long run average nearer 15x), after a more than 40 per cent surge in the share price so far in 2022, does not seem to leave a lot of value on the table for investors.

Compass Group (CPG) – the world’s largest food services outsourcing business has the rare attraction that both Covid and food price inflation can be viewed as positive drivers for reshaping its target markets. Today more than half of the world’s staff/student/pupil canteens are still managed in-house but these two macro pressures have highlighted the wisdom of passing this service out to a professional third party. Profits are moving up rapidly and are passing pre-Covid levels but the shares remain more than 10 per cent below pre-pandemic levels and the PE is 10-12 per cent below long run norms for the group. The share price looks to have more recovery in it yet and, with a slew of buybacks expected in the next two years, investors might reasonably expect to see double digit returns.

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