Aon is a London-listed insurance broker but is much more than that. It also has a significant risk advisory business covering healthcare and a large pensions business. Although its shares have had a solid run in the past few years, I expect its continued, proven expertise and consolidation through a merger with Willis to unlock future value for shareholders, so rate the company as a buy.
The Enduring Appeal of Insurance Broking
When I first encountered insurance brokers I wondered how long they were destined to survive. Consumers will scramble around on the Internet to save a few dollars in renewing their car insurance directly instead of using a broker, in many cases. Why would a much larger insurance purchaser – such as a property company or shipping line – with sophisticated capabilities in-house shell out huge sums to a broker rather than deal with a handful of likely underwriters itself?
In fact, brokers perform a number of functions. They bring expertise in a given area, they know the market better than customers can, they bring scale and they also can help with claims management and the like. So, as well as expertise, they may be able to offer financial benefits even while charging a hefty commission. That is why large-scale insurance brokers have not gone away and it is also why I do not expect them to go away.
Broking offers a way to get some of the financial benefits from the insurance market without the risks attendant upon investing in insurers directly. Plus in principle they ought to be more stable than underwriters, whose results in any year can be significantly affected by claims levels, especially if they are involved in writing more exotic or large-scale lines of business.
That is the basic case why I expect insurance broking to survive for decades. Given the importance of scale and expertise in that summary, I think that in insurance broking, if choosing an investment option, it makes sense to focus on one of the big players. There are just a handful of these, and after Marsh & McLennan (MMC), Aon is the biggest. It is gearing up to increase in size significantly following its merger with Willis, due to complete in the first half of 2021.
Why Aon is an Attractive Name in Insurance Broking
Aon has a long-established global broking practice. But there is a lot more to the company than just insurance broking. Based on its expertise in risk assessment and handling which it has acquired through its involvement in the insurance market, it has evolved over time into a wider-ranging risk management consultancy.
In addition to broking, Aon has a consulting and advisory offering. This is not merely a bolt on to the broking business but a substantial business in its own right.
Source: company Q3 earnings presentation
This spread of businesses helps ensure that the company is not overexposed to downfalls in demand in the insurance markets.
Source: company Q3 earnings presentation
The base insurance business provides a strong foundation for the business, while areas such as health and data services which leverages Aon’s deep pools of risk-related data allow for future growth in non-insurance areas.
There is Still Value
Aon shares have had a long run up.
Source: Google Finance
The yield of just over 1% is unexciting and the shares were trading at record levels earlier this year, although they have since fallen back somewhat. Nonetheless, I still see value in them at their current price.
The P/E ratio is around 21x. That is not cheap but I also think it is reasonable for a blue chip professional services firm with a growth runway. The Willis tie up – providing it proceeds smoothly – should improve earnings thanks to synergy savings, which means the price will have some upward space in which to move simply to maintain its P/E ratio.
Even without that, though, the company has a proven history of free cash flow margin growth.
Its free cash flow performance continues to be impressive, with Q3 free cash flow growth of 91%, to $1.9 billion.
Source: company annual report
EPS moves around but in the long-term the company has had a solid earnings growth story which I expect to continue – EPS grew 6% in the third quarter. While the company prefers to use non-GAAP adjusted EPS figures, even the basic EPS figures show a broadly improving trend albeit with big quarterly swings.
Chart compiled by author using data from company quarterly filings
Aon: Continued Growth Should Lead to Long-Term Share Price Growth
Aon is not cheap and I wouldn’t quantify its shares as a bargain. However, I do see further upside in years to come. The business has proven it can grow earnings over the long-term, and the merger with Willis should bring synergy efficiencies which further boost operating margins, already at 25.5% for the first nine months of 2020. The company’s leading position in an attractive industry will be burnished, and over the long-term I expect continued share price growth to reflect that.
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.