Since I first argued that MetLife (MET) was substantially undervalued here, the stock has soared by 24.1%, beating the Dow Jones by 3x. I continue to find meaningful room for appreciation given solid momentum and the Street, accordingly, rates shares near a "strong buy". Aon (AON), which provides insurance and reinsurance brokerage, also receives bullish sentiment on the Street. Based on my review of the fundamentals, DCF model, and multiples analysis, I find that both of these firms are attractive.
From a multiples perspective, Aon comes across as more expensive. It trades at a respective 16.8x and 11.7x past and forward earnings with a dividend yield of 1.3%. The company is valued at 108% of its historical 5-year average PE multiple. MetLife trades at a respective 7.2x and 7.5x past and forward earnings with a dividend yield of 2%. The company is valued at 58% of its 3 Digit MG Group PE multiple.
At the fourth quarter earnings call, Aon's management addressed decent performance:
"[O]rganic revenue was 3% overall, with growth across Risk and HR Solutions highlighted by 4% growth in both Reinsurance and Outsourcing. Adjusted operating margin decreased 70 basis points, driven by an increase in intangible amortization expense over the prior year. And finally, EPS increased 15%, driven by strong underlying performance and effective capital management. For the full year, organic revenue growth was 2% overall, an improvement from flat in 2010 and minus 1% in 2009. Adjusted operating margin decreased 180 basis points, which includes 140 basis points of intangible amortization impact and the inclusion of Hewitt results. Finally, EPS increased 5%, driven by strong underlying performance and effective capital management".
EPS of $0.97 was roughly in-line with consensus. Organic growth was strong in HR Solutions, but expenses in the segment more than offset this upside story. Indeed, the main concern over Aon is the weaker-than-expected results at HR Solutions. Management further needs to provide greater clarity over earnings trends, in general. The lack of visibility over the effect of Hewett's integration has only magnified this issue, but cash flow has solidly improved and the cost savings target is reasonable at $355M. Insurance pricing is expected to further normalize, which will help brokerage in the process. Note that insurance growth tends to lags that of the economy and, thus, the stock offers more visibility than what a cursory review would suggest.
Consensus estimates for Aon's ESP forecast that it will grow by 8.2% to $3.56 in 2012 and then by 15.2% and 8.5% in the following two years. Modeling a CAGR of 10.6% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $56.66, implying 18% upside.
MetLife, which operates more specifically as an insurer, has demonstrated strategic strength. Management announced that it would stop operating its retail mortgage loan origination business, which reduces the risk that regulators will label the financial institution "systemically important". MetLife has further hedged against domestic stagnation by dramatically increasing scale through the takeover of ALICO from AIG. Investors should note that the takeover also has no impact on economic income so long as it is not repatriated.
Consensus estimates for MetLife's EPS forecast that it will grow by 1% to $5.07 in 2012 and then by 10.3% and 10.9% in the following two years. Assuming a multiple of 10x and a conservative 2013 EPS of $4.95, the rough intrinsic value of the stock is $49.50, implying 30.6% upside.