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Marsh & McLennan: A Recession Resistant Insurance Services Play

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About: Marsh & McLennan Companies, Inc. (MMC)
by: Greg Wajda
Summary

MMC is a strong services-oriented company with little exposure that actual insurance companies have to rates and pricing.

Shareholder returns have been strong across 3 different channels.

A recent acquisition weakens the numbers slightly, but we believe the long-term story is compelling.

Introduction

Marsh & McLennan (MMC), a top insurance broker & consulting firm, just completed a very large acquisition and posted some strong underlying results for Q2 2019.

In this article, I examine the acquisition, the tremendous goodwill it created, and how the company performed during the last recession and what that tells us about the prospects for the future.

Q2 2019 Results & JLT Acquisition

The company had a decent quarter, with difficult to compare numbers because of a large acquisition not represented in Q2 2018. Underlying revenue growth was decent at 4%. Operating income fell slightly, although if you trust the company's adjusted operating income, it grew by a large margin.

On a non-adjusted basis, the quarter was a miss compared to Q2 2018. On the back of lower operating income, higher interest expense, and other acquisition-related charges, net income fell almost 37%.

Source: Q2 2019 Earnings Release

The big news, of course, was the close of the JLT acquisition. This enhances the firm's consulting and insurance divisions and gives them more exposure to the UK, Europe, and, to a lesser extent, the rest of the world.

Source: Q2 2019 Earnings Release

The balance sheet looks to have gotten substantially worse in the short term, as for the company's billions, they bought mostly goodwill and intangible assets, and little real assets other than $2b in interesting right of use assets that showed up on the balance sheet.

Source: Q2 2019 Earnings Release

This is not unexpected, however, given that JLT reflects much the same capital structure as MMC. As most companies do, I expect them to quickly work to bring down the debt load, but the company is still in a normal leverage range. Even with the best intangible accounting estimates, much of the value of consulting and insurance brokerages are difficult to capture.

2018 & Long-Term Results

2018 revenue increased at a 4% underlying clip year over year or over $900m if you include acquisitions. Operating income hit record levels for the company and net income was up big over 2017, despite being short of 2016's record highs.

Looking deeper, there are a few one-time items I would like to point out. Typically, I either ignore these type of items or add them back if management is doing some non-GAAP obfuscation to try to hide poor results, but MMC has some interesting ones I think are worth discussing.

As a result of their pending acquisition, at the end of 2018 (now completed), of JLT for $5.6 billion, they entered into some hedging transactions since JLT is a UK-based company. The company is recording unrealized gains and losses on this hedge in their income statement, which resulted in a $325 million paper loss in 2018. This was offset by an almost $500m lower tax expense for 2018, largely due to the US tax reform increasing their tax expense the prior year.

These netted out to make 2018 look stronger than it really was, but it was still a good year as operating income, which excludes both of the aforementioned items, shows.

Long-Term Results And Shareholder Returns

Looking longer term, since the Great Recession, MMC has been performing very well. They have been growing sharply year over year in almost all metrics, driven by strong operating performance and a healthy dose of acquisitions.

Shareholder Returns

MMC has certainly become more aggressive with both the amount and size of their acquisitions lately, although, since a strategy reset in 2009, this has remained a continued focus. One would have liked them to perhaps do the opposite, with large acquisitions just after the recession with them now tapering off, but timing the market is hard.

How Did Mmc Perform In The Last Recession?

One of my favorite things to research is how companies performed in the last recession. Why? Well, we are so far moved from this event that it gets harder to imagine what it was like and that it could happen again.

I often predict how the next recession will not be as serious but nobody really knows. I see so many charts of income and revenue for companies going perfectly straight up and to the right that I need another side, another viewpoint to balance and inform my buy decisions. So, I find 2008 and 2009 annual reports to reveal a host of useful information to make an educated decision.

2008 was an interesting year as MMC saw leadership changes and restructuring across all of their business units. It is clear that the consulting branch of MMC did not fare well in the recession. Services dramatically slowed as businesses cut back on everything from new projects to any non-essential expenses.

Interestingly, it appears that the text and tone of the company at that time told a much darker story than the cold hard numbers did, looking back on them after almost a decade.

The company took some modest goodwill charges in both years and net income was all over the place, even turning negative in 2009, but under the hood, the business still performed admirably. An interesting thing about MMC is that their cost structure is largely based on salaries to their large and highly paid workforce. They don't have a lot of expensive, hard-to-cut-or-sell assets like factories, vehicles, and the like. It appears as though the company is able to quickly correct and resize its cost structure when business slows.

Valuation And Conclusion

Fidelity shows $5.00 in expected EPS next year, with a $97 price at publication that gives the company about a 19-20x multiple of future earnings. The S&P 500 is trading at about the same multiple.

Peers like Aon (AON) and Accenture (ACN) trade at 30+ and 22 times earnings respectively. The company has had 20%+ ROE the past two years, well above the average S&P 500 company.

Chart Data by YCharts

I think where MMC is trading now is a fair price for the business. While not achieving the ranks of great businesses quite yet, I think it is just below top tier and pulled through the recession better than most, and I see no reason it could not do admirably in the next downturn. I wouldn't mind starting a small position here and then waiting for a pull back around $70-80 to fill out the position.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.