Marsh & McLennan Refocuses For Long-Term Value

| About: Marsh & (MMC)
This article is now exclusive for PRO subscribers.

After facing what seemed to be an endless stretch of lawsuits, Marsh & McLennan Companies (NYSE:MMC) appears to be on track to have a full year free of major litigation and finally some normalized earnings. After all, MMC hasn’t had a year of clean earnings for almost half a decade since all their legal troubles and restructuring began.

Consolidated operating income was $939 million in 2010 compared with $778 million in 2009. If you were to exclude lawsuit settlements and restructuring costs, consolidated operating income was $1.5 billion in 2010 and $1.3 billion in 2009. Going forward, average analyst estimates put EPS at $1.86 for fiscal 2011 and $2.13 for fiscal 2012; resulting in forward P/E ratios of 14.35 and 12.50, respectively.

In his 2010 annual letter to shareholders, President and CEO Brian Duperreault themes his letter to the tune of a more refocused Marsh & McLennan:

I think it’s fair to say that we are not the same company we were just a few short years ago – and to illustrate this point, we have stopped referring to ourselves as ‘MMC’. We have returned to our historical roots by reinstituting the corporate name Marsh & McLennan Companies.

So far the return to historical roots seems to be working. As a result of our strong cash generation, MMC was able to deleverage its balance sheet with the payment of a $550 million debt maturity. They also increased their quarterly dividend by a total of 10% over the last year in addition to extending their share repurchase program from $500 million to $1 billion.

Success through Diversification

MMC is a global professional services firm providing solutions in the areas of risk, strategy, and human capital. It is the parent company of a number of the leading companies including:

  • Marsh, risk and insurance intermediary
  • Guy Carpenter, risk and reinsurance intermediary
  • Mercer, human resource consulting, outsourcing and investment services
  • Oliver Wyman, management consulting
    MMC Consolidated Revenues, as of 12/31/2010

In addition to a diversified revenue base, MMC frequently engages in new ventures and acquisitions, as well as divestitures, to fund future shareholder returns.

In October 2008, Marsh established the Marsh & McLennan Agency to be one of the premier insurance agencies in the United States, meeting the needs of mid-sized businesses across the country. In the past 15 months, the agency completed 10 acquisitions that have added annualized revenue approaching $300 million.

Ultimately, MMC expects this business to exceed $800 million in annual revenue. In the past few years, Marsh has also sold off old divisions, including Putnam Investment Trust and Kroll, to refocus for future acquisitions.

Leverage Risk & Falling Short in Free Cash Flow

Although MMC appears to be off to a fast start, lagging debt and inadequate free cash flow may cause alarm for investors with a higher risk tolerance. Standard & Poor’s keeps their long-term credit rating just north of non-investment grade at BBB-. MMC pension obligations also may cause the company’s earnings and cash flows to fluctuate as it remains slightly underfunded. Their long-term debt to assets holds close to 20% at year-end 2010 with interest coverage from continuing operations at 4.03 (if you include discontinued operations, interest coverage holds closer to 9.5).

As previously mentioned, MMC’s free cash flow generation is quite inadequate considering its spending. It’s hard to see how approximately $501 million (MMC’s free cash flow in 2010) is inadequate, but when you factor in the amount of share repurchases, dividend increases, and debt repayments, there is just not enough money to fund all three simultaneously.

To continue its current spending trajectory, MMC will have to keep its current debt level as status quo, continue divestitures to make-up for short falls, or grow business organically. Perhaps MMC should rethink at least part of its strategy before spending all its free cash flow on non-growth generating activities.

Going Forward

Although still facing tough challenges ahead, MMC looks to have most of its troubles behind it. Consequently, most analysts do rate MMC as “overweight” as they continue to see growing value in the share price over the coming quarters. While not a screaming bargain, maybe MMC is worth a go for the investor willing to wait out a few bumps on the road.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.