As part of my resolve to pare down my list of dividend generating investments from sixty to a more manageable forty or so, I plan on doing an in-depth analysis of each one, starting from the top. In a previous article, I stressed the importance of having a basic understanding of the underlying business of the companies in a portfolio, so as to better evaluate and validate one's personal investment decisions.
First on my list is Arthur J. Gallagher & Co., symbol (AJG). The company is an international insurance brokerage and risk management services firm headquartered in Itasca, Illinois with operations in 17 countries. They offer client-service capabilities in more than 110 countries around the world through a network of correspondent brokers and consultants. 72% of its revenue base is concentrated in the insurance brokerage business with the remaining 28% coming from risk management services and corporate investments. The Risk management business is mostly one of a third party administrator handling claims processing for a fee.
To say that AJG is an interesting company on the move is a gross understatement. For the first nine months of 2012, they closed 43 acquisitions bringing in over $170 Million of additional revenue. Included within their 17% year-to-date growth in brokerage revenue fueled mostly by the acquisitions, they also experienced organic growth of 4% during the same period. Organic growth excludes commission and fee revenues generated during the first twelve months by an acquired company. I will comment more on recent activity later, but first here is a recap of the last three years key metrics:
2009 | 2010 | 2011 | |
Revenue USD Mil | 1,729 | 1,864 | 2,135 |
Gross Margin % | 81.2 | 77.5 | 78.9 |
Operating Income USD Mil | 211 | 203 | 208 |
Operating Margin % | 12.2 | 10.9 | 9.7 |
Net Income USD Mil | 129 | 174 | 144 |
Earnings Per Share USD | 1.28 | 1.66 | 1.28 |
Dividends USD | 1.28 | 1.28 | 1.32 |
Payout Ratio GAAP EPS % | 97 | 82.1 | 103.1 |
Shares Mil | 101 | 105 | 113 |
Book Value Per Share USD | 8.71 | 10.21 | 11.02 |
Operating Cash Flow USD Mil | 212 | 232 | 283 |
Cap Spending USD Mil | -24 | -25 | -40 |
Free Cash Flow USD Mil | 188 | 206 | 243 |
Free Cash Flow Per Share USD | 1.87 | 1.96 | 2.20 |
Payout Ratio of Free Cash Flow | 68.8% | 65.2% | 61.4% |
The 2012 dividend is $1.36 equating to a 3.8% yield at the current stock price of $35.90. As the table above illustrates, the company has a history of generating more than adequate free cash flow to sustain its dividend.
Among the acquisitions closed during the year, 23 were brokers specializing in benefits which contributed over $50 Million in additional revenue. During the company's Q3 conference call, management stressed the recognition of small business brokers needs for Gallagher's expertise and modeling systems to cope with and navigate the new laws and changes brought about with Healthcare Reform.
Moving on to the recently announced Q3 2012 financial results, note the table below:
Q3 2012 | Q3 2011 | 9 Mos 2012 | 9 Mos 2011 | |
Revenue $Mil: | ||||
Brokerage | 479.7 | 421.9 | 1338.5 | 1143.1 |
Risk Management | 142.2 | 139 | 426.9 | 403.1 |
Corporate | 28.5 | 1.9 | 81.7 | 10.1 |
Total Company | 650.4 | 562.8 | 1847.1 | 1556.3 |
EPS $: | ||||
Brokerage | 0.40 | 0.41 | 1.03 | 0.97 |
Risk Management | 0.09 | 0.07 | 0.28 | 0.19 |
Corporate | 0.01 | -0.07 | 0.02 | -0.23 |
Total EPS | 0.50 | 0.41 | 1.33 | 0.93 |
EBITDAC* $Mil: | ||||
Brokerage | 117.4 | 95.7 | 294.2 | 241.2 |
Risk Management | 22.8 | 17.7 | 68.7 | 46.9 |
Corporate | -13 | -7 | -26.2 | -22 |
Total EBITDAC $Mil | 127.20 | 106.40 | 336.70 | 266.10 |
* EBITDAC is an acronym used by some private equity firms and Gallagher as somewhat of a proxy for operating cash flow. More specifically it is "the measure of net earnings before interest, income taxes, depreciation, amortization and the change in estimated acquisition earn-out payables." Got it? Simply put, earn-outs are the earnings of the acquired target company often used to calculate the final acquisition price to be paid by the acquiring company.
One final note before summing up is the recognition of the activity contained in the "Corporate" segment just below brokerage and Risk Management. Gallagher has investments in Limited Liability Companies that own clean coal production plants which produce refined coal using proprietary technology. In their third quarter earnings announcement and reaffirmed on the conference call, management claims that these investments collectively have the potential to generate future earnings in excess of $12 Million in after tax earnings per quarter through 2020. We'll see about that. To read the full text of the company's Q3 earnings report, click here.
Finally, this forensic exercise into Arthur J. Gallagher has only increased my enthusiasm for its future prospects and will not be on my cut list. In fact, I will increase my position using funds from the sale of two other holdings that I sold today. Two down, eighteen to go.
Disclosure: I am long AJG.
