Marsh & McLennan: Trees Don't Grow To The Sky, But Brokers Might
Summary
- Marsh & McLennan is the top insurance broker and a rare example of a successful serial acquirer.
- Margins have expanded impressively in the last decade, overcoming a soft insurance market most of the time.
- The insurance market has improved lately, and premium pools are expected to grow strongly in the long term.
- MMC's valuation is not expensive relative to peers.
Hiroshi Watanabe/DigitalVision via Getty Images
As noted here, Marsh & McLennan Companies, Inc. (NYSE:MMC) has had quite a bit of a run. Good performance continued into 2022, with an impressive set of Q1 numbers:
Revenue growth of 10%, to $5.5Bln, Net Income of $1.1Bln, EPS of $2.30 vs $1.99 in prior year's first quarter.
Leading the way was its Risk and Insurance services segment (“RIS”), with $3.5Bln in revenue, or about two-thirds of the total. This business has a higher margin than the consulting side, so we know that more than two-thirds of earnings come from RIS.
Two businesses sharing an AAA client list
Risk expertise is MMC´s main flag. The company has developed a consulting business focused on health/pension/wealth and human resources to market to its client list. According to the company, 95% of Fortune 1000 companies are clients. This is a nice group to sell things to, and MMC does it well. You can’t get to +$20Bln in sales if you are not doing things right and adding value along the way. More impressive than revenue growth, 2021 became the 14 th consecutive year of increasing operating margins.
MMC earnings presentation
Although both businesses have healthy and resilient margins, it is the RIS business that carries the most weight. With $125Bln of premiums placed through its brokerage operations, MMC is comfortably the largest in the world.
An insurance broker - all brokers - serve two masters; its clients get advice on their policy wording, design, etc. Insurance can be complex, especially on the specialty side of things. The insurers need brokers for distribution and reward them for bringing in profitable business. On the reinsurance brokerage side, the client becomes the insurance company, which in this case will be seeking to offload a portion of its risks to reinsurers.
This “two-step” process: from policy buyer to insurer and then from insurer to reinsurer means a given premium amount will be indirectly subject to two placements and two brokerage commissions. Two bites of the same apple, in a way. In total, MMC earns about 10% on premiums ($12.4Bln in revenues on $125Bln premium placement). This is not exact, as RIS does include some non-premium related business, like engineering risk surveys, but these are not very material to revenues.
Premium pool going forward
Therefore, growth in premium volume translates to growth at MMC. And without material incremental investment, by the way.
Industry-wide premium volume (for Property & Casualty) is a factor of the following:
- GDP growth, the bigger global economies get, the larger the asset base and level of business that needs insurance.
- The penetration of insurance in emerging markets.
- Types of risk that are insurable. Evolving risks that were not discussed 20 or 30 years ago like cyber or climate risk have come to the forefront.
- Capacity supply and demand. The amount of capital (somebody´s net worth) ready to write business in the reinsurance market and the demand for it.
A recent study by reinsurance giant Swiss RE forecasts premiums will increase from $1.8Tln in 2020 to $4.3Tln by 2040, a growth rate of 4.3%.
Swiss Re
Automobile (“motor” in the report) is expected to remain the main component of premium pool, though with a reducing share. Gaining share are liability (as societies develop) and property (climate risks and growth). The linked study is an interesting read for long-term holders of auto insurers like Progressive (PGR) or GEICO - a relevant Berkshire Hathaway (BKR.A, BRK.B) subsidiary - and for anyone with direct exposure or interest in insurance.
As the largest broker in the world, MMC has the biggest sails for catching such a tailwind. Inflation will push premium volumes higher. Asset replacement costs rise together with inflation and losses do as well, insurers will adjust as required.
The next phase
Since the GFC, we have inhabited a world characterized by low inflation, low GDP growth and very low interest rates. The last item, low rates, attracted new capital into insurance, as a way to earn some yield. These factors helped create a prolonged “soft” market for insurance with low premium growth, but all of them are reversing.
There is probably a limit to the margin enhancements discussed above, and MMC may be approaching it, I don’t know. Each year I think they have topped, they outdo themselves. What I do know is that there are tangible advantages to being the top player in an industry were reputation is key. And that their acquisition strategy yields obvious synergies without which margin improvement like we've seen would not be possible. An extreme example would be its largest to date, the acquisition of JLT, which I have covered previously.
In addition to the growing premium pool, there is reason to expect gradual accretion to value from network effects at play. The larger their network (clients/insurer and insurer/reinsurer) the more valuable. Size also enhances acquisition capacity/credibility and talent retention. But none of this is a secret…as its valuation implies.
Valuation
From a price to sales basis, it sits squarely in the middle of peers. Aon plc (AON) at 5x commands the top valuation spot (or bottom, depending on one´s viewpoint) and Willis Towers Watson (WTW) at 3x on the lower end.
These are high numbers, but remember that more than 20 cents on each dollar of sales makes it all the way down the income statement.
On capital allocation front, MMC scores well, all growth has come at the cost of no increase in shares (actually, a slight decrease of over 7%). AON has repurchased aggressively while MMC has focused on acquisitions. Both routes have proven profitable for shareholders.
All in all, the company is not cheap, but quality usually never is.
Putting it all together
Marsh & McLennan has a been focused on all the right things. It has improved margins from the low double digits to +20's more recently in the span of a decade. Insurance industry conditions remain favorable for supporting further growth in the top line for MMC. It is unlikely that margins will improve for much longer, but I have thought so for years now and been wrong.
Valuation is not cheap, but it has taken a break recently together with the market as a whole. Price to sales reached 5x and has receded to a more rational 4x. Should margins top out at 25%, the implied earnings yield is 6.25%. Even if the company only grows at the expected 4.3% of the premium pool going forward (i.e., no market share gain or loss), a long term holder can expect about around an 11% return. Not bad. But there is excess cash flow to deploy, and if it is used either to continue acquisitions (increasing market share) or repurchase shares (also increases market share, per share), or both, an even better outcome would result.
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Disclosure: I/we have a beneficial long position in the shares of MMC either through stock ownership, options, or other derivatives. 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.