The worst is yet to come as unemployment climbs to over 20-year highs Sodexo’s 9M
numbers on 1 July highlighted a deceleration in underlying organic growth from 5.8% in H1
to just 2.9% in Q3. But we estimate the worst is yet to come. While it is clear that
unemployment is on the rise across the globe, we fear that the sector has yet to feel the full
brunt. With SG’s economists forecasting an acceleration in job losses up to Q4 09/Q1 10,
underlying fundamentals (and thus newsflow) for both Compass (CPG) and Sodexo (SW)
look likely to deteriorate well into 2010. In the Catering segment, we believe this is likely to
put increasing pressure on LFL volumes, normally one the most profitable levers of organic
growth. The Service Vouchers segment (c.30% of SW’s FY09e EBIT) could also disappoint.
For starters, we believe unemployment hurts this business just as much as it does catering.
Adding to these worries, we also estimate that the current, low interest-rate environment
could reduce the financial income derived from investing the vouchers’ face value (SGe 20%
of Vouchers revenues, 60% of EBIT).
􀁑 We are ‘Underweight’ on the Catering segment Within the broad Hotels & Leisure sector,
we believe Catering will be the last segment to weaken in terms of the cycle but also the last
to recover. Thus with newsflow and fundamentals likely to deteriorate further, we prefer
segments such as Hotels, where in some regions at least the underlying trends appear to
have stabilised, although they are still deep in negative territory. In terms of catering stocks,
CPG looks better positioned, in our view, to offset volume declines with cost efficiencies;
however, after three years of cost rationalisation already this will not be an easy task. While
SW has the most defensive portfolio mix, its track record of cost cutting is not as strong as
the company is perhaps targeting longer term market share gains.
􀁑 Main stock picks Resilient trading over the last 12 months has put CPG and SW on
premiums in their local markets, based on 2-year forward P/Es: +9% for CPG vs FTSE100,
+57% for SW vs SBF120. But with headwinds just starting to gather strength, these
premiums look increasingly untenable: the last time employment levels fell significantly
(2002-05) both stocks traded at much lower levels: CPG -20%, SW in line. After CPG’s
respectable 25% 12M performance relative to the FTSE, we are moving to Hold on the stock
(from Buy) with a DCF, FCF, and multiple-based TP cut from 420p to 360p. On SW, we
reiterate our Sell rating with a €31 TP (was €32). In the broader sector, our preferred stocks
are Accor (Buy, TP €43), Starwood (Buy, TP $23) and InterContinental (Buy, TP 880p).
􀁑 Catalysts With volumes likely to slow considerably over the next 12 months, we believe
margins will be a key area of focus for investors. CPG’s Q3 trading update, due on 23 July,
should show yet more deceleration in growth; however mounting pressure on margins is
unlikely to become apparent until SW and CPG report FY results in the autumn.

Contents
4 Sector anatomy – presentation of the sector
5 Sector anatomy – performance and valuation
6 Sector – leading indicators, 1998 to Q4 2010e
7 Investment summary
8 Valuation
13 Driving profitable growth during good times…
17 … and flexing costs when times are bad
23 Question marks on Vouchers too
29 Our top-down model
35 Compass update
38 Sodexo update