Description

Marsh McLennan is the largest insurance broker in the world and a long-term compounder with higher-than-average organic growth rates in the industry given its large consulting businesses.  Shares trade at $198 at EV/2024E EBITDA of 16.0x, which reflects fair value for a business of this quality and is in-line with its longer-term historical valuation.  5-year returns are anchored around ~12% IRR / 1.7x MOIC assuming no multiple expansion, a 10% EBITDA growth rate (reflecting recent organic growth trends and the progress on the cost improvements).  Upside could be in the ~16% IRR / 2.1x MOIC area assuming 13% EBITDA growth (higher organic growth from better execution of the cost improvement plan) and multiple expansion to 17.0x.

Market backdrop

Insurance brokers continue to benefit from a firm P&C pricing cycle, a unique inflationary environment, and a tight labor market.  The inflation protected nature of insurance premium pass-throughs combined with the non-discretionary nature of property, casualty and benefits insurance purchases provide downside protection.  Investor focus is likely to remain on the sustainability of favorable organic growth trends into 2024. Stability of the growth trend is likely to increase with incremental visibility into favorable 1H24 P&C market dynamics, with potential offsets from uncertain macro narratives (i.e. rates and others).

In terms of exposure growth, inflation and employment levels will continue to drive the narrative. Consensus U.S. nominal GDP expectations stand at 5.8% due primarily to stronger than expected employment and persistent inflation. A stable 3.7% unemployment rate is predicted to continue through the end of the year. P&C pricing may modestly decelerate in 2H23 from strong absolute levels, these aforementioned factors drive an above-average outlook for brokerage organic growth. The P&C pricing trajectory sits between an improved insurer ROE outlook due to rising fixed income yields/improved underwriting profitability, and insurer caution around the inflationary environment and increased weather events. Thus, pricing is likely to remain steady overall, though specific insurers with less property exposure could be pressured slightly.

P&C renewal premium change (includes pricing and exposure growth) may decelerate in businesses less exposed to property markets (where prices have been increased less in recent quarters). The magnitude of deceleration is mixed, however, primarily due to business mix differences, varying degrees of economic headwinds, and exposure to transactional business that falls outside of the typical renewal cycle. Mid to high single digit organic growth in retail P&C globally is likely. High-single-digit to low-double-digit premium growth in Reinsurance brokerage. Employee benefits is expected to be flat or a modest tailwind to overall organic growth as strong demand and rising medical costs are partially offset by solid yet decelerating wage increases and employment growth. Modestly decelerating organic growth in E&S markets is likely as stamping office submission flow has remained resilient despite a lower property weighting and CA premiums inflected positively (+16% 3Q23 vs -5% in 2Q23). Overall, pricing and exposures remain healthy and continue to provide for above-average organic growth levels compared to long-term averages.

Overall commercial pricing increases to remain fairly steady, though company reported pricing indices could be pressured by the lower weighting to Property business QoQ, driving some deceleration. Insurers continue to weigh higher investment yields and improved underwriting over the past several years against ongoing inflationary pressures on claim costs. Property pricing is exhibiting the strongest pricing increases as increased frequency and severity of weather events and higher Property-CAT reinsurance pricing filters into primary pricing models; a trend we think could continue well into 2024. On the other end of the spectrum, pressure on workers’ compensation and public D&O pricing remains a headwind, with incrementally more D&O business in 2H vs 1H. Additionally, while cyber pricing increases remain solidly positive in the high-single-digits according to MarketScout, the rate of increases have decelerated to +9% from +13%/+23% in 2Q23/3Q22. The MarketScout/Ivans is showing a greater than typical divergence, with Ivans pointing to modest broad-based acceleration in P&C pricing, while MarketScout data points to fairly broad-based pricing deceleration in the quarter. Notably, MarketScout’s over commercial pricing index fell to 3.5% in July (before improving to 4.1% in Aug), which represents the first sub 4% data point since July 2019. Our overall view for modest pricing deceleration hasn’t changed much however, and we consider pricing indices alongside more bullish pricing comments from industry participants. Given uncertainty regarding the trajectory of inflation in addition to its longer-term impact on reserves, we would expect insurers to communicate their intent to continuing seeking pricing increases at relatively similar levels. We note that at its September investor meeting, AJG management expected similar P&C market conditions continuing over the course of 2023 and into 2024.

The primary near term macro focus surrounds the health and trajectory of brokers’ more discretionary consulting businesses, which are typically the first to show economic pressure in more difficult environments - and as a result could see deceleration in these areas. Additionally, continued higher fiduciary investment income as expectations for short term yields in 2024/2025 continue to incrementally rise (30-60bps in 2Q23). Internationally exposed brokers are likely to guide and report modestly more FX pressure than previously communicated due to dollar strengthening in FY 2023, though a favorable YoY impact to revenues from dollar weakening YoY still exists.

A key question at the operating model level is can operating leverage outweigh rising variable costs? Expectations for margin expansion should be optimistic; Brokers face rising variable costs YoY from more normalized levels of T&E (though less than 1H23) and from wage growth. However, the majority of brokers’ cost structure is not increasing in-line with headline inflation, with producer compensation largely tied to revenues. Operating leverage, fiduciary investment income, and expense efficiencies will support margins going forward

MMC background

Marsh McLennan is a global professional services firm offering clients advice and solutions in risk, strategy and people. Its businesses include: Marsh, the insurance broker, intermediary and risk advisor; Guy Carpenter, the risk and reinsurance specialist; Mercer, the provider of HR and investment related advice and services; and Oliver Wyman Group, the management, economic and brand consultancy. With 76,000 colleagues worldwide and annual revenue of $17 billion, the Company provides analysis, advice and transactional capabilities to clients in more than 130 countries.

The Company conducts business through two segments: (a) Risk and Insurance Services includes risk management activities (risk advice, risk transfer and risk control and mitigation solutions) as well as insurance and reinsurance broking and services. The Company conducts business in this segment through Marsh and Guy Carpenter. (b) Consulting includes health, wealth and career services and products, and specialized management, economic and brand consulting services. The Company conducts business in this segment through Mercer and Oliver Wyman Group.

MMC's primarily fee-based revenues benefit to a lower degree from the tailwinds of P&C pricing and inflation, and the company is more economically sensitive than other peers. Marsh produces among the highest organic growth rates in the sector (9-10%+), which is likely to provide more than offsetting tailwinds. This stems from the company's 6k net organic hires in 2021 (76k 2020 employee base), which will add more than 1pp to organic growth in 2024 due to lagged revenue production.  Additionally, operating leverage stemming from organic growth, in combination with MMC's 1) scale, 2) the highest relative (and absolute) capex investment over the past decade, and 3) strong fiduciary investment income will lead to continued efficiencies and margin expansion. These benefits will offsetting some of MMC's usual economic sensitivity in a recessionary scenario.  MMC would like be more of an average fundamental performer in a downturn, as opposed to under pressure historically.

MMC vs. peers on key operating metrics

Thesis points

Organic growth rivals commissions-oriented brokers, and think the company product suite is well positioned for the future: ~5-8%+ organic growth is possible in 2024-2026, driven by Risk & Insurance Services (RIS) and partially offset by Consulting; which translates into a top 3 organic growth rate on average over the coming years amongst the peer group, along with total company pricing benefit of ~3.5pp, falling to ~2pp in 2024/25. Reinsurance (Guy Carpenter), and U.S./Canada and Latin America within Marsh drive the greatest organic growth opportunities, driven by pricing, inflation, and talent. Reinsurance represents a favorable product given expectations for pricing and exposure tailwinds, and Guy Carpenter remains well positioned to take advantage of property market dislocation with management noting 2021 hires already producing results for the firm in this area.  MMC's 6k organic hires in 2021 could add ~1pp to organic growth over each of the next 3 years on average, with peak revenue impact in 2023/24, given the lagged effect between hiring and revenue growth, partially stemming from standard 2-year non-competes for experienced producers.

MMC's scale, global revenue base, and breadth of product offering, will support the company in creating/maintaining competitive advantages and serving multinational corporations as holistic provider of risk management and consulting solutions. The company is most weighted to the high-growth Outsourced Chief Investment Officer (OCIO) business amongst peers as it now represents over half of the company's Wealth business. Additionally, the companies 13% exposure to Asia pacific, and 34% non-U.K. international exposure more broadly should serve to support strong revenue growth for the next decade.

The company is more economically sensitive versus peers, but with offsets from recent producer adds/organic growth prospects: Over the last two recessions, MMC's fundamental performance has been worse than insurance broker peers, largely stemming from more discretionary project based work in the company's consulting segment. Most exposed areas are Oliver Wyman (management consulting; 13% of revenues), and the companies HR/ Career Consulting business (4% of revenues) and the company's brokerage is typically more defensive versus smaller account peers due to the fee-based nature of larger account revenues.

Significant room for RIS margin expansion driven by operating leverage and above-average fiduciary investment income exposure relative to brokerage operations: 80-100bps of operating margin expansion in 2023/2024 and 50bps in 2025 are possible. RIS likely to drive expansion with 60-120bps of expansion, partially offset by a lower degree of expansion in Consulting. Margin expectations as conservative on operating leverage, as fiduciary investment income leads to a favorable 90bps/60bps impact to RIS and total company 2023 margins alone. The company's $10bn of fiduciary investment income is the highest in the peer group relative to its brokerage operations, where the majority of investable fiduciary balances stem from.

Expense improvements: Despite MMC having the greatest scale amongst the brokers, the company does not have the highest margins - even when broken down by segment. Considering this combined with MMC's material capex investments and expectations for strong organic growth show there are likely further efficiencies to be harvested. This point was recently cemented on MMC's 2022 and 2023 earnings calls, as management highlighted expectations not only for slower growth in the all other expense category within RIS, but for reductions over time.

The company expects to deploy $4bn of capital this year through dividends, buybacks and M&A: MMC has a shareholder friendly and diversified approach to capital deployment, electing first to pay/grow its dividend and acquire businesses (particularly on the brokerage side) and use the remaining amount for share repurchases. Generally this approach results in roughly ~$2bn per year in buybacks over the coming years, in addition to about $1bn on M&A annually. Free cash flow will likely grow double digits in 2024/2025 following organic growth trends and support capital deployment objectives.

Valuation and simple model

Risks

• Slowing organic growth as a result of a hiring slowdown or producer retention issues
• Macro issues in insurance broker business related to unemployment, rate shocks and other recessionary-related headwinds, which MMC's consulting business is more indexed to

Mitigants

• Capital deployment program, higher than peer organic growth rates, producer hiring and defensive larger accounts broking business provides a large offset
• Current macro setup favorable relative to other recessionary periods for insurance intermediaries
• Only 3 down years of broker premium growth (2008-2010) in last 70 years

Catalyst

Ramp of new producers to drive above-average organic growth, capital deployment as well as upside expense savings