Value Stocks in the Insurance Sector

Excerpt from the Q1 2007 letter to shareholders from David R. Carr Jr. and Larry Coats Jr., managers of the Oak Value Fund:

Given the extent to which we talk and write about our quest to find sustain-ably advantaged businesses, we believe this quarter provides us with a great opportunity to point out that “we put our money where our mouth is”. That’s because we believe the three stocks we bought were each good businesses as evidenced by their underlying attractive economics. The additions we made were Aon, Microsoft, and 3M. Each has produced returns on invested capital that are either already high or improving dramatically, each is capable of serving an increasingly global client base, each has relatively new yet highly respected management teams, and each is optimizing its balance sheet. In short, we believe that each of these high quality businesses represents a very good investment, at the price we paid.

Aon (AOC) - Aon is one of the largest commercial insurance brokerages in the world. The company competes in three businesses: insurance brokerage, consulting, and supplementalinsurance. The Fund already maintains a position in Willis Group Holdings, Ltd. (WSH) (not to mention the Fund’s longstanding position in Berkshire Hathaway (BRK.A)) and as we continued our work, we concluded that there should also be room in the Fund portfolio for Aon. While the two companies compete, our investment theses are different for the two companies. We still believe Willis has unique attributes such as its ability to grow due to its smaller size and more aggressive sales culture.

Aon has the potential to dramatically improve its financial performance by rationalizing its cost structure and improving margins. The company has grown significantly over the years through numerous mergers and acquisitions, and despite its excellent competitive positioning versus companies such as Marsh & McLennan (MMC), there is still considerable room for improving economic outcomes for its shareholders. Said another way, Aon grew into a global powerhouse within the insurance brokerage business almost despite itself. While Patrick Ryan, who founded the company in 1965, was no doubt an industry visionary, we believe that his McKinsey-bred successor, CEO Greg Case, is well on his way to making Aon into the operating company it needs to be to compete in this global industry going forward...

A key component of our “good businesses with good management at attractive prices” philosophy is that of valuation. As a reminder, our goal is to invest in advantaged businesses when Mr. Market offers them up to us at prices that we believe offer an attractive margin of safety. We typically draw this line in the sand at a 30-35% discount to our estimate of the company’s intrinsic value. In our estimation, the allocation of the Fund’s collective capital to these businesses during the quarter clearly met this threshold.

See also: other fresh money buys from the Oak Value Fund here and here.