March 20, 2015 Aon Plc NEUTRAL Current Recommendation Prior Recommendation Outperform Date of Last Change 06/18/2012 Current Price (03/19/15) $98.91 Target Price $104.00 SUMMARY (AON-NYSE) Aon s fourth-quarter earnings surpassed the Zacks Consensus Estimate primarily on organic revenue growth, improved segmental performance and efficient capital deployment. The company s durability lies in its core business strengthening initiatives, efficient capital deployments and cost savings generated from its restructuring programs. Moreover, strong M&A activities, divestitures and restructuring initiatives position Aon to generate long-term growth. However, stiff competition, ongoing legal hassles and foreign currency fluctuations remain headwinds. Although Aon expects to create significant shareholder value in 2015, a weak financial position, competitive pressure and an increased debt burden raise concern. SUMMARY DATA 52-Week High $100.74 52-Week Low $79.43 One-Year Return (%) 16.80 Beta 1.05 Average Daily Volume (sh) 1,044,090 Shares Outstanding (mil) 280 Market Capitalization ($mil) $27,695 Short Interest Ratio (days) 1.70 Institutional Ownership (%) 86 Insider Ownership (%) 1 Annual Cash Dividend $1.00 Dividend Yield (%) 1.01 5-Yr. Historical Growth Rates Sales (%) 9.8 Earnings Per Share (%) 15.0 Dividend (%) 16.3 using TTM EPS 17.3 using 2015 Estimate 16.1 using 2016 Estimate 14.4 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Low, Type of Stock Large-Growth Industry Ins-Brokers Zacks Industry Rank * 173 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 2,915 A 2,897 A 2,794 A 3,209 A 11,815 A 2014 2,947 A 2,919 A 2,880 A 3,299 A 12,045 A 2015 2,980 E 2,989 E 2,943 E 3,536 E 12,448 E 2016 12,947 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $1.11 A $1.11 A $1.13 A $1.54 A $4.89 A 2014 $1.28 A $1.25 A $1.29 A $1.89 A $5.71 A 2015 $1.32 E $1.33 E $1.28 E $2.20 E $6.13 E 2016 $6.87 E Projected EPS Growth - Next 5 Years % 15 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Headquartered in London, Aon plc is a British multinational corporation that offers risk management services, insurance and reinsurance brokerage, human resource consulting and outsourcing services worldwide. The company operates in more than 120 countries. As an insurance broker, Aon utilizes its resources to develop individual as well as group insurance programs. It offers its services globally across personal lines, mid-market companies and multinational companies. In Oct 2010, Aon Corporation a wholly-owned subsidiary of Aon plc acquired Hewitt Associates, an American company providing human capital and management consulting services. Hewitt merged with the consulting services business of Aon to form Aon Hewitt. The two reportable segments of Aon are: The Risk Solutions (accounted for 65% of revenues in 2014) segment provides advisory and insurance and reinsurance brokerage services. To help its clients manage risks, the segment offers consultation and negotiation services through Aon s global distribution network. The HR Solutions (35%) segment collaborates with organizations to provide solutions to their complex benefits, talent and related financial challenges. Moreover, this segment designs, implements, communicates and administers human capital, retirement, compensation, talent management and so on to enhance operating performance of these organizations. REASONS TO BUY Aon is a leading insurance and risk brokerage company globally. As a risk consultant, the company provides alternative captive management vehicles that are not available in the traditional insurance markets to help its clients manage risks successfully. On the other hand, for insurance brokerage, Aon depends on dynamic financial analysis and securitization to enhance its capacities. This enables it to gain competitive advantage over other players in the industry, thereby making it one of the major insurance and risk brokers. The company has been growing across the emerging markets, particularly in Asia and continental Europe, where it has been delivering strong results. To further increase its operating strength, the company has been divesting non-core operations. In 2014, Aon divested two businesses in the Risk Solutions segment that led to a pre-tax gain of $24 million. Earlier, during 2010 2013, the company divested a total of nineteen businesses in the Risk Solutions segment and four businesses in the HR Solutions segment. These divestitures generated a pre-tax gain of $4 million in 2010, $1 million in 2012 and $10 million in 2013 adding to the liquidity. Hence, the sale of these businesses not only appears profitable but is also likely to drive operating leverage of the company, going forward. Aon has been upfront in adopting inorganic growth strategies like acquisitions and partnerships. In 2014, Aon acquired eleven businesses in the Risk Solutions and two in the HR Solutions segments. In Feb 2015, Aon acquired UK-based Kloud, the largest dedicated Workday consultancy outside the U.S. This deal should help Aon become the largest provider of Workday services in Europe. Earlier, the company acquired Lorica Employee Benefits in Jun 2014, National Flood Services in Jul 2014 and a Lima, Peru-based risk and insurance solutions provider, Grana y Asociados in Aug 2014. These acquisitions expanded Aon s health and benefits business, flood insurance solutions, and risk and insurance solutions operations respectively. The company intends to continue with its acquisition activities globally, particularly in the emerging economies to strengthen its base. Moreover, the partnership with AXIS Insurance in Sep 2014 to provide law firms a solution to protect their businesses, livelihood and reputation, is helping Aon Affinity widen its professional liability business. Moreover, while the expansion of the coverage options under the Aon Active Health Equity Research MGI Page 2
Exchange in Aug 2014, which will be available from Jan 2015, is expected to boost revenues. The launch of Aon Delegated DC Services for trust-based defined contribution schemes in Oct 2014 is aimed at efficient investment and better member outcomes. Moreover, the company s collaboration with HelloWallet in Apr 2014 and Visier in Jun 2014 complements Aon Hewitt s extensive suite of solutions, thus boosting the clientele and revenues going forward. We believe that such acquisitions and partnerships will continue to accelerate long-term growth. Aon has devised a number of restructuring plans that have helped it control mounting expenses and also generate savings. This should enhance the financial strength of the company going forward. The Aon Benfield Plan led to a cumulative expense savings of $146 million in 2012, while the Aon Hewitt Restructuring plan executed between 2010 and 2013 generated annualized savings of $329 million in 2013. Another $402 million of savings was garnered in 2014, as anticipated. As a result, after spiking 33% in 2011, total operating expenses rose merely 2% in both 2012 and 2013 and 1% in 2014. Cost savings from the restructuring plans are expected to make way for margin expansion as well. The operating cash flow of Aon has been strong over the years. Operating cash flow increased at a four-year CAGR of 19.6% to $1.6 billion in 2014, driven by net income growth and decrease in pension contributions. As a result, free cash flow (operating cash flow minus capital expenditure) rose at a four-year CAGR of 15.6% to $1.4 billion in 2014. We believe that the company s investments in innovative solutions position it well to generate higher cash flows in the long term. Free cash flow generation helps the company to implement efficient capital management strategies that boost shareholder confidence on the stock. The company authorized a $5 billion share repurchase program in Apr 2012, under which shares worth $1.1 billion were left as of Sep 30, 2014. In Nov 2014, an additional $5 billion share repurchase program was authorized bringing the total authorization to $6.1 billion. During the fourth quarter, the company repurchased shares worth $500 million, with $5.6 billion remaining for repurchase as of Dec 31, 2014. Moreover, Aon consistently pays dividends. Higher cash flows led to an 11% hike in its regular dividends in Apr 2013, which was followed by a 43% rise in Apr 2014. We expect cost curbing and capital management to continue boosting the company s operating leverage and earnings in the coming quarters, thereby retaining the confidence of ratings agencies and investors. REASONS TO SELL Aon has been issuing debts occasionally to repay outstanding debts. Total debt burden of the company increased at a three-year CAGR of 7.6% to $5.6 billion at 2014-end due to an increase in commercial paper outstanding. The commercial paper is primarily issued to repay earlier debt obligations and meet short-term working capital needs. Consequently, Aon s debt-to-capital ratio deteriorated from 34.8% at 2012-end to 35% at 2013-end and 45.9% at 2014-end. High level of leverage increases the company s borrowing costs and financial risk, thereby making additional borrowing expensive going forward. Aon faces competition from players with greater market share, more financial resources and stronger brand recognition. Its Risk Solutions business, in particular, is facing intense competition from industry giants like Marsh & McLennan Companies and Willis Group Holdings. Aon is exposed to intense competition from insurers and reinsurers who market their products independently. Further, as a global corporation, Aon is exposed to foreign currency fluctuations, which had an unfavorable impact of $0.11 per share on its operating earnings in 2014, $0.03 per share in 2013 and $0.06 per share in 2012. Given the global economic volatility, foreign currency fluctuation is expected to persist for some time thereby affecting earnings adversely. Fluctuation in exchange rates and increased competition are likely to hamper the company s business opportunities and have an adverse impact on profitability going forward. Equity Research MGI Page 3
Aon has been facing litigation issues that challenge its financial strength. In 2010, one of the retail insurance brokerage subsidiaries of Aon was sued in the Tennessee state court by one of its clients, Opry Mills Limited Partnership, for $200 million. Again, Aon Hewitt received a notice from Phillips UK related to negligence and breach of duty. Yet again, in Dec 2012, Mazeikiu Nafta sued an insurance brokerage subsidiary of Aon in London for $125 million citing failure in provision of substantial business interruption coverage. Legal hassles not only drain cash, weighing on the financial position, but also tarnish the company s goodwill and thereby mar investor confidence. Additionally, the global economic weakness, repricing of credit risk and deterioration of the financial markets are weighing on customers demand for the retail and reinsurance brokerage products of the company, which could affect operational results adversely. RECENT NEWS Aon Hewitt Acquires UK-based Kloud Feb 3, 2015 Aon Hewitt acquired UK-based Kloud, the largest dedicated Workday consultancy outside the U.S. Aon Beats Earnings Estimates on Organic Revenue Growth Feb 6, 2015 Aon s fourth-quarter 2014 operating earnings of $1.89 per share exceeded the Zacks Consensus Estimate of $1.86. The results were also higher than the year-ago quarter figure by 23%. Aon s earnings improved year over year on account of organic revenue growth, operating margin improvement across both the segments and effective capital deployment. Including extraordinary items worth $0.33 per share, Aon s net income per share was $1.56, comparing favorably with $1.14 in the year-ago period. The company s total revenue went up 3% year over year to $3.3 billion on higher organic revenues (up 6% from the year-ago quarter). Revenues, however, missed the Zacks Consensus Estimate of $3.4 billion. Total operating expenses in the quarter under review were $2.7 billion, down 1% year over year. Lower formal restructuring costs, decline in intangible asset amortization and favorable impact from foreign currency translation led to the improvement. Segment Update Risk Solutions: Total revenue came in at $2.1 billion, up $3 million year over year. Organic growth of 3% in commissions and fees and a 1% increase in commissions and fees from acquisitions, net of divestitures led to the improvement in revenues. Adjusted operating earnings increased 5% year over year to $507 million while adjusted operating margin increased 110 basis points to 24.7% during the quarter. The improvement was largely owing to organic revenue growth, return generated on investments and cost containment measures taken. Organic revenues at the Retail Brokerage segment increased 4% year over year. This growth came on the back of higher organic revenues from the Americas business (up 7%), led mainly by better business in Latin America and US Retail, and the favorable impact from the timing of some revenues. Equity Research MGI Page 4
Organic revenues at the Reinsurance segment were up 3% mainly on increase in net new business in treaty placements, along with improvement in capital market transactions and advisory businesses, and facultative placements. However, these positives were partially mitigated by an unfavorable market impact in treaty placements. HR Solutions: Total revenue of $1.3 billion reflected an 8% year-over-year rise owing to 10% organic growth in commissions and fees. However, this was partially mitigated by a 1% decline in commissions and fees associated with acquisitions, net of divestitures and a 1% unfavorable impact of foreign currency translation. Adjusted operating earnings increased 19% year over year to $296 million while adjusted operating margin improved 210 basis points to 23.5%. Organic revenues at Consulting Services increased 4% year over year. This was driven by improvement in the U.S. retirement for investment consulting and businesses across Asia Organic revenues at Outsourcing increased 15%, driven by the addition of new clients in HR Business Process Outsourcing and improvement in health care exchanges. Full-Year Highlights Aon s 2014 operating earnings of $5.71 per share exceeded the Zacks Consensus Estimate of $5.68. The results were also higher than the year-ago quarter figure by 17%. Organic revenue growth and efficient capital deployment led to the year-over-year improvement. Including extraordinary items worth $1.05 per share, Aon s net income per share was $4.66, comparing favorably with $3.53 in the year-ago period. Aon s total revenue went up 2% year over year to $12 billion on organic growth in commissions and fees. Revenues, however, came in below the Zacks Consensus Estimate of $12.1 billion. Financial Position As of Dec 31, 2014, cash and cash equivalents of Aon were $374 million, down 21.6% from $477 million as of Dec 31, 2013. Total assets of Aon as of Dec 31, 2014, were $29.8 billion, down from $30.3 billion at 2013-end. Net operating cash flow came in at $1.64 billion in 2014, up from $1.63 billion n 2013. The improvement came from an increase in net income and a decrease in pension contributions. Capital expenditure in 2014 increased 11.8% year over year to $256 million. Free cash flow in 2014 decreased 1% from that at 2013 to $1.4 billion. This was attributable to increase in capital expenditures, partially mitigated by high operating cash flow. Long-term debt increased to $4.8 billion as of Dec 31, 2014 from $3.7 billion as of Dec 31, 2013. Debt-tocapital ratio of Aon rose 1090 bps from 2013-end to 45.9% as of Dec 31, 2014. Share Repurchase Update In 2014, Aon bought back 25.8 million Class A Ordinary shares for nearly $2.25 billion. Equity Research MGI Page 5
VALUATION Aon shares currently trade at 16.1x our earnings estimate for 2015, at about 2% discount to the 16.5x industry average. On a price-to-book basis, the shares trade at 4.3x, at 115% premium to the 2.0x industry average. The valuation on a price-to-book basis looks attractive, given the trailing 12-month ROE of 23.1% that is above the industry average of 10%. Our six-month target price of $104.00 equates to about 17.0x of our earnings estimate for 2015. Combined with the $1.00 per share annual dividend, this target price implies an expected return of 5.7% over that period. Additionally, the quantitative Zacks Rank for Aon is currently 3, indicating no clear directional pressure on the shares over the near term. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Aon Plc (AON) 16.1 14.4 15.0 12.2 17.3 17.8 11.2 Industry Average 16.5 151.7 11.7 14.2 16.7 169.6 9.9 S&P 500 16.6 15.5 10.7 14.5 18.2 18.4 12.0 Marsh & McLennan Companies Inc. (MMC) 18.9 16.7 13.3 16.0 20.4 20.7 12.3 Hannover R (HVRRY) NA NA NA 9.5 10.0 9.7 4.1 Erie Indemnity Company (ERIE) 23.4 21.7 10.0 3.7 27.4 28.4 16.7 Arthur J Gallagher & Co. (AJG) 17.4 15.3 12.3 11.8 20.5 25.6 18.3 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Aon Plc (AON) 4.3 4.3 1.7 23.1 0.7 1.0 12.1 Industry Average 2.0 2.0 2.0 10.0 0.2 1.8 15.2 S&P 500 6.2 9.8 3.2 25.4 NA 2.0 NA Equity Research MGI Page 6
Earnings Surprise and Estimate Revision History Equity Research MGI Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of AON. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1133 companies covered: Outperform - 15.2%, Neutral - 75.2%, Underperform 8.8%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Research Analyst Copy Editor Lead Analyst QCA Rageshree Bose Priyanka Bhattacharyya Meenakshi Sharma Tanuka De Equity Research MGI Page 8