The Long and Short
Arthur J. Gallagher and insurance brokers offer stability
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Insurance brokerage credits offer stability relative to traditional property and casualty names, as ongoing underwriting risk and rate volatility impact the broader industry. Among those names, Arthur J. Gallagher (AJG: Baa2/BBB/BBB) provides investors with attractive relative value versus industry peers. While the insurance brokerage industry remains fragmented with significant consolidation pressures driving management teams, AJG offers a stable credit profile commensurate with solid BBB ratings as it balances discretionary cash flow usage between growth, shareholder compensation and maintaining sufficient capital and liquidity. AJG is relatively new among investment grade issuers in the segment, but the intermediate notes offer generous compensation relative to the larger, more established creditors, e.g. AON and MMC.
Exhibit 1. AJC intermediate notes versus IG insurance broker peer group
Source: SanCap, Bloomberg/TRACE G-spread indications
AJG 5.50% 03/02/33 @ +155/10YR; G+155; 5.10%; $103.03
Issuer: Arthur J. Gallagher & Co.
CUSIP: 04316JAD1
Amount outstanding: $350 million (Index-Eligible)
RATING: Baa2/BBB/BBB(pos)
Global Issue
Traditional P&C insurance underwriters struggled throughout 2022 amidst one of the top 5 highest years of global catastrophe costs. The market is therefore poised for significant upward pricing pressure in 2023, which should continue to benefit the profitability of the global insurance brokers. Furthermore, ongoing rate volatility creates investment portfolio risk that is only present among insurance underwriters and has a more limited impact on the brokerage group.
AJG’s brokerage segment makes up the vast majority of its annual business at roughly 75% of total revenue. The remainder is generated through its risk management segment, and its corporate segment, which includes investment stakes in clean coal energy operators. Nearly three quarters of sales are generated domestically in the US, with the bulk of the remainder generated in the UK. While this limits AJG’s scale relative to global competitors AON and MMC, it continues to gradually diversify its operations while maintaining its top tier performance in domestic markets.
AJG is the world’s fourth largest broker with annual revenue of over $8.5 billion in 2022, which is up from $7.0 billion as of 2020 with the addition of Willis Re in late 2021. AJG remains highly active in M&A to continue funding its growth ambitions, while maintaining very consistent credit metrics. The Willis Re acquisition that closed in December 2021 for $3.25 billion was the most material transaction of the past several years. The majority of activity continues to be smaller, strategic bolt-on acquisitions. AJG has made more than 10 of these transactions year-to-date without material impact to credit metrics. While it is difficult to rule out a larger-scale, debt-funded M&A transaction, regulators blocked the AON/WTW transaction that was proposed back in 2021, which has since curbed the appetite for and speculation about consolidation among the bigger operators in the segment.
Gross leverage as of year-end 2022 was 2.69x, with net debt leverage of 2.55x. The company appears poised to maintain leverage in a range of 2.5-to-3.0x in the intermediate term. Meanwhile, AJG’s EBITDA-to-interest coverage as of year-end was at 9.0x. That compares with similar interest coverage of about 10x among the larger, higher-rated industry leaders AON and MMC. Those companies also maintain debt leverage in a comparable 2.5-to-3.0x range as well.
AJG reports first-quarter earnings next week on April 27. The company recorded solid results for the fourth quarter with adjusted EPS of $1.54 topping the $1.49 consensus estimate. Top-line revenue of $2.03 billion also came in slightly above expectations. The company’s current EBITDA margin of roughly 30% exceeds that of both MMC (27%) and WTW (24%).
AJG appears to have a very adequate liquidity and maturity profile. The company had $342 million in cash on its balance sheet as of year-end 2022. It has just under $950 million remaining on its revolving credit facility through next year with only $333 million outstanding. AJG has $250 million in debt maturity in the current year, after which the next maturity is not until 2031. While relatively new to the public debt issuance (inaugural debt deal in 2021), the company has demonstrated its ability to access the market with two follow-up debt launches at affordable levels over the past two years.
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