AON - Aon: An Underwhelming But Unfazed Giant In An Overwhelming Market Landscape

2023-04-18 02:49:27 ET

Summary

• Aon plc had a lackluster but stable performance amidst inflationary headwinds.
• Liquidity stays in decent shape, but the company is highly leveraged.
• Macroeconomic uncertainties persist, but improvements are visible.
• Its consistent dividends are well-covered but a bit underwhelming.
• The continued stock price increase makes it expensive.

With the events that have transpired in the past three years, wealth management has become crucial for many individuals. It was evident in 2022 as inflation hurt the finances of millions of households and businesses. Even a giant like Aon plc ( AON ) was subject to its risk. Macroeconomic disruptions hampered its growth potential instantly. Yet, it displayed its durability and resilience as it withstood inflation blows. It emerged unfazed, especially in 4Q. It bounced back from the gloomy 2Q and 3Q performance. Growth may not be robust, but it was stable, matched with increasing margins.

It also has adequate cash levels that can cover its operating capacity and dividends. However, dividends are quite disappointing for a large-scale company. We can verify it in the stock price, given the low yield. Unsurprisingly, AON stock price shows overvaluation. The stock price uptrend already exceeded the intrinsic value of the company.

Company Performance

The financial sector faces challenging moments as macroeconomic headwinds remain intense. Even insurance brokers and health and wealth management companies are not exempt. Despite being a financial service giant, Aon plc felt its impact. The weaker mid-year performance in 2022 reflected it. On a lighter note, Aon showed its capacity to cushion its bow. Growth may be lackluster, but it remained a resilient and flexible company. The company maintained a sound performance to balance its growth potential and margins.

The operating revenue amounted to $12.479 billion , a 2.4% year-over-year growth. While growth appeared underwhelming, we can see its consistency even before the pandemic. It sped up in 2020 and 2021, which we can attribute to near-zero inflation and interest rates. Unlike the Great Recession, the pandemic recession attracted more capital inflows. Lower fees and a more suitable environment for investments made wealth management and consulting firms a staple. Also, the pandemic highlighted the importance of having health insurance. All these worked in favor of Aon. In 2022, the company stabilized its growth, but inflation intensified and set a new all-time high. To be more precise, we will focus on the quarterly values. From 1Q to 3Q 2022, revenues dropped, which was most evident in commercial risk solutions and wealth solutions management. It was a logical trend since inflation mostly affected various investments, leading to market pessimism. Prices also skyrocketed, which strained the budget of individuals and businesses. More importantly, interest rates rose by 75 bps for four consecutive quarters, which enticed more savings rather than investments. Despite this, the company stabilized its operations with its pricing strategy to maintain its retention rate.

In 4Q, the operating revenue bounced back to $3.13 billion, a 1% year-over-year growth. It was also lackluster, but the improvement from 3Q was impressive at 16%. The same factors drove its rebound, particularly its pricing strategy and inflation. Inflation remained elevated in 4Q, but it landed at 6.5%, a 29% difference from the 9.1% peak. The rebound was faster in the reinsurance and health solutions with organic growth of 9% and 7%. Even better, health solutions organic growth was the same as in 4Q 2021. Its commercial risk segment also rose, but it lagged at 4% versus 12%. Overall, the organic growth averaged 5%.

But what made Aon plc stay afloat is its efficient asset management. It also played a vital role in partially offsetting revenue reduction. Amidst the overwhelming prices, expenses remained manageable. They increased at a slower-than-expected rate. Although it wasn’t enough to offset the impact of lower revenues, it helped the company stay viable. The operating margin reached 29% a bit higher than the 2021 margin. In 4Q, it was 32% versus 31% in 4Q 2021. It was also a massive rebound from 21% in the previous quarter.

This year, Aon may see the same headwinds. But it continues to adjust and cope with it. Macroeconomic indicators are more manageable today. Its near-term growth may still be low, but improvement may be sustained. We will discuss more of it in the following section.

Why Aon plc May Stay Afloat This Year

The economy is still plagued with uncertainties. In fact, the Fed anticipates a mild recession this quarter as interest rates continue to increase. Meanwhile, the UK inflation has already decreased, but it has not stabilized yet. In contrast, the US inflation shows that the conservative approach of the Fed has paid off. It landed at 5% , 45% lower than the 2022 peak and 17% lower than in the last month. Interest rates keep increasing, but they appear to be more manageable, given the recent increase of 25 bps. It was a substantial decrease from the previous increment. Given the current macroeconomic trend, interest rate increases may continue to cool down. In turn, Aon may have increased flexibility in its commissions and fees. It may also have more demand as cost-of-living adjustments improve. More investments will come as people shift to more inflation-linked products. Also, there may be more capital inflows when people choose investments over savings. These may not materialize soon, but 2024 may show better results as macroeconomic changes become more stable.

Its financial positioning can also ensure Aon’s adequacy to face more headwinds and sustain its capacity. Cash reserves are enough, amounting to $1.14 billion. However, it must watch out for its borrowings, which are 36% of the total assets. The company may be overleveraged, given the negative equity. It may also pose some risks since interest rates are still increasing. Thankfully, only 9.8% of the total borrowings are maturing within the year. Also, the Net Debt/EBITDA remains low at 2.43x. The company earns enough to cover its borrowings. Likewise, the Cash Flow Statement shows decent liquidity. Its Cash Flow From Operations covered CapEx and Dividends. The FCF/Sales Ratio of 24% shows Aon succeeded in converting a substantial portion of revenues into cash. It continues to balance profitability and liquidity with sustainability.

Stock Price Assessment

The stock price of Aon plc has been exciting over the past decade. The uptrend stays evident despite the noticeable price correction in 2022. At $326.01, the stock price is 0.2% lower than last year’s value but 22% higher than the 2022 dip. The EV/EBITDA Model shows that the stock price is still fairly valued, given the target price of ($77.31 B EV - $10.54 B Net Debt) 205,400,000 shares = $325.07. Yet, the price is approaching its maximum level.

Meanwhile, Aon sustains its dividend payouts, but yields are disappointing at 0.69%, way lower than the S&P 500 average of 1.69%. It shows that the stock price may be too expensive relative to dividends. On a lighter note, dividends remain well-covered with the Dividend Payout Ratio of 18%. To assess the stock price better, we will use the DCF Model.

FCFF $2,817,000,000

Cash $1,140,000,000

Outstanding Borrowings $1,130,000,000

Perpetual Growth Rate 4.8%

WACC 9.2%

Common Shares Outstanding 205,400,000

Stock Price $326.01

Derived Value $311.97

The derived value shows that the stock price is overvalued. There may be a 5% downside in the next 12-18 months. Investors must be more careful before buying shares.

Bottomline

Aon plc faces disruptions that may continue to hamper its growth, but it remains a stable company. It has adequate cash reserves to sustain its capacity size and capital returns despite the high financial leverage. Dividend payments continue to increase, but yields are too low. Also, the stock price appears overvalued and higher than the intrinsic value of the company. The recommendation, for now, is that Aon plc is a hold.

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