The Long and Short
Arthur J Gallagher attractive relative value
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Recent wider spreads have improved corporate relative value as investment grade debt touches its widest level since September 2024. The most recent update on sector attractiveness shows the insurance segment as some of the strongest value in the index. Within that sector, insurance brokerage credits continue to offer stability relative to traditional property & casualty names amidst ongoing underwriting risk and rate volatility across the broader industry. And following the dramatic California wildfires, it appears more likely that higher catastrophe losses could lift renewal rates more than was originally anticipated heading into the new year. Insurance brokers typically benefit from rising underlying P&C rates. Among those names, Arthur J. Gallagher (AJG: Baa2/BBB/BBB+) appears to provide investors with attractive relative value versus peers, particularly in the long end of the curve.
As was recently highlighted, the smallest IG player Brown & Brown (BRO: Baa3/BBB-) offers the widest trading bonds in the sector overall. However, with recent changes in spread dynamics, the larger AJG now appears to offer best compensation relative to commensurate credit risks for longer dated securities (exhibit 1). Furthermore, by establishing or adding to holdings in AJG, investors can take advantage of the relative attractiveness of the broader insurance segment to rest of the IG landscape following the more recent shake-out in spreads (exhibit 2).
Exhibit 1. AJG bond curve versus IG insurance broker peer group
Source: Santander US Capital Markets, Bloomberg/TRACE G-spread indications
While traditional P&C insurance underwriters struggled to maintain profitability in recent years amidst periods of heightened global catastrophe costs, those market conditions served to benefit the profitability of the global insurance brokers, and the segment appears poised for strong margins over the near-to-intermediate term. Moderating industry trends suggest insurance brokers should see a steady performance in 2025 as EBITDA margins continue to strengthen. Meanwhile, ongoing interest rate volatility creates investment portfolio risk that more directly affects insurance underwriters versus a more limited impact on the brokerage group.
Exhibit 2. Investment grade sector spread percentile ranks
Source: Santander US Capital Markets, Bloomberg Corporate Bond Sector Indices
In late 2024, AJG significantly increased its debt footprint with a $5 billion debt issuance in December. The proceeds of which will go to fund a portion of its $13.5 billion acquisition of AssuredPartners Inc, which was announced earlier that month. The remainder of the acquisition cost is being financed with an $8.5 billion common stock issuance, also executed around the same time. The merger is expected to close before year-end. There is no $101 special mandatory redemption language on the new debt issues, as the company indicated the proceeds would go to general corporate purposes, including other acquisitions, if the deal does not close.
The AssuredPartners acquisition will be the largest in company history. Like most of its peers, AJG has remained highly active in M&A. With the funding already lined up, and management re-committing to smaller deals, acquisition-related credit risk appears limited for the time being. Previously, 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 M&A activity has traditionally been smaller, strategic bolt-on acquisitions. AJG often makes dozens of those per year without material impact to credit metrics. While the insurance brokerage industry remains fragmented with significant consolidation pressures driving management teams, AJG continues to offer 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.
S&P revised the outlook on AJG to Positive from Stable in early December, reflecting the rating agency’s expectation that top-line growth from the acquisition will enable the company to make incremental improvements to credit quality over the next two years. Meanwhile, both the other major rating agencies maintain their stable outlook on AJG’s ratings, with the expectation that leverage will only be temporarily elevated following the acquisition and be paid down over time. Fitch raised their rating to BBB+ from BBB in late 2023 but stated they would be comfortable maintaining it as long as management makes good on their plans to get leverage back down.
Debt leverage is expected to initially increase to about 2.7x from its position of 2.5x (using S&P adjusted leverage). Gross leverage has remained in a consistent range of 2.5-to-3.0x over the past several years. Meanwhile, AJG’s EBITDA-to-interest coverage has also remained in a very consistent range in the low-8-to-high-9x range over the past five years as well. Those metrics continue to compare well with its IG peer group.
AJG is now the world’s third largest broker with annual revenue of over $11 billion in 2024, which is up from less than $6.0 billion in 2020 with the addition of Willis Re in late 2021. AJG’s brokerage segment makes up the vast majority of its annual business with more than 85% 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 two thirds 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 has made efforts to gradually diversify its operations – though the AssuredPartners deal will skew operations a little more domestically. The 11th largest US insurance broker’s pro forma annual revenue was about $2.9 billion at the time the deal was announced and operates entirely within the US.
AJG boasts a very solid liquidity profile, even after accounting for the anticipated closing of their large acquisition. Prior to the December debt and equity raises, the company was carrying over $2 billion in cash and equivalents on the balance sheet (currently around $15 billion in anticipation of the merger). In addition, AJG has $1.7 billion available under its revolving credit facility through 2028. next year with only $333 million outstanding. There is only a $15 million debt maturity in the current year, and a little over $300 million in loan maturities due the following year.
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