Summary:
Marsh & McLennan's strategic acquisitions and restructuring initiatives have
generated new clients, triggering growth. The upcoming quarters should benefit from
improved pricing, stable ratings, strong capital management and expense control
initiatives. Its segments Risk and Insurance Services and Consulting are also
performing well. However, exposure to currency volatility due to huge international
presence, pension costs and integration risks from acquisitions raises concern.
Nonetheless, the company delivered three straight quarters of positive surprise with
positive estimate revisions witnessed over the last 60 days. The Zacks Consensus
estimate for the second quarter is currently pegged at $0.91 per share, translating to a
year over year growth of 14%.
Reasons to Buy:
- Marsh & McLennan is a dominant player in its industry. Its Guy Carpenter brand, holding a quarter of the market share, has been improving through cross-selling opportunities, new business production and high retention rates. Another unit – Mercer, the investment consulting and management wing continues to generate robust growth with strategic acquisitions and has been modestly contributing to Marsh & McLennan’s annual revenue. Meanwhile, the stabilization of rates has provided cushion to the company’s pricing initiatives and hence, augmented financial results. With a history of outpacing its peers, Marsh & McLennan has a strong potential to outperform in the future as well, banking on its size, diverse product offering, global presence and technical expertise.
- The company’s organic growth story remains impressive. Since 2009, the company has invested nearly $7 billion for growth and efficiencies. This includes capital expenditure of $2.2 billion, 115 acquisitions and investments totaling approximately $4.6 billion and an increase in head count of over 10,000 colleagues. Vis these acquisitions, the company has enhanced Marsh’s scale and size of business across geographies, particularly in the Asia-Pacific, Africa and Latin America, thereby substantially contributing to top-line growth and insurance margins. These efforts have also led the company to grow revenues at a CAGR of 4% from 2010-2015. The company has grown underlying revenues between 3% and 5% annually for six years in a row despite headwinds. With 4% growth exhibited in the first quarter, the same marked 12th straight quarters of improving underlying revenues by atleast 3%. For full-year 2016 too, the company projects underlying revenue growth within the 3–5% range as well as significant margin expansion in both the operating segments. The company also anticipates strong bottomline growth at a level which will enable it to reach the long-term target of 13%.
- Marsh & McLennan is focused on cost reduction and expense management. Over the last couple of years, the company has been implementing cost-saving initiatives by divesting redundant units and moderating its expenses on compensation and benefits and other operations. These helped the company enhance its organic growth and operating leverage. These actions have resulted in cost efficiency, which increased the company’s operating income at a five-year CAGR of 22.67% (2010–2015). However, the first quarter operating income dipped 0.3% to $733 million year over year. Also, operating expense declined 1.7% year over year to $10.5 billion in 2015. Although the company witnessed a rise of nearly 5% in operating expenses in the first quarter 2016, we expect prudent cost management should aid margin expansion going forward.
- Marsh & McLennan has always effectively deployed capital to enhance its shareholders value. The company deployed $3.2 billion in 2015 for share buyback, dividend payment and acquisitions up from $2.3 billion in 2014 and $1.2 billion in 2013. In the first quarter too, the company returned $200 million to its shareholders. This effective management of capital has been made possible by the sufficient generation of cash flow from operations by the company. Operating cash flow improved to $1.34 billion in 2013 and grew to $2.1 billion in 2014. However, the company has been witnessing cash outflows over the past few quarters. Nevertheless, riding on operational strength the company expects a turnaround in this particular metric in the near term. With respect to dividend, the board of directors recently approved a dividend hike of 9.7%. For 2016, the company expects to deploy $2.3 billion of capital across share repurchase, acquisitions and dividends. Such initiatives have helped boost shareholder confidence.
Risks:
- The company’s non-U.S. based revenue that is exposed to foreign exchange fluctuations is approximately 55% of total revenue. Exchange rate movement has had a significant impact on the company’s earnings (by $0.03 per share in the first quarter). Revenues in the Risk and Insurance services and consulting segment declined by 6% and 7% respectively, which led to an overall revenue decline of 6% for 2015. However, in the first quarter of 2016, revenues grew 2% and 6%, in the Risk and Insurance services and Consulting segments, respectively. Nevertheless, the company anticipates forex volatility to negatively impact such segmental revenue growth in the near term.. Also, for 2016 the company expects adverse foreign exchange to impact the earning per share by $0.07.
- Although the company is taking up restructuring and cost reduction initiatives to accelerate growth, operating expenses continue to rise on account of increased tax and legal expenses, compensation, benefits and claims along with other underlying expenses. The company incurred about $961 million in restructuring costs during 2007–2013. Moreover, it is too early to predict an eradication of this uncertain expense. Tax expenses escalated at a five-year (2009–2014) CAGR of 94.6%, thereby weighing heavily on the bottom line. Meanwhile, higher tax refunds, employee compensation, acquisition-related and other expenses are expected to limit expansion in operating cash flow. Adjusted tax rate is expected to be high in the future as well. Though adjusted tax rate in first-quarter 2016 was 28.5% compared with 29.4% in the prior-year quarter, the company projects adjusted tax rate of 29% for the remainder of 2016.
- Marsh & McLennan is encumbered with significant pension obligations toward its employees that totaled $13.5 billion in 2013, up from $12 billion in 2011. Meanwhile, the company made significant contributions worth $646 million in 2013, including $250 million for pre-payments of expense in 2014, increasing overall pension expense from $613 million in 2012. Despite this contributions, the company’s pension obligations continue to remain significantly underfunded. Infact, the company estimates retirement expense for 2016 to decline by $30 million or $0.04 per share. This is also reflected in higher compensation and benefits costs, including increased pension costs and higher consulting costs, which have been additionally burdening the financial leverage and cash flow while influencing the debt credit ratings.
