Aon Beats Q3 Earnings on Operational Growth, Capital Action

Aon plc’s (AON) third-quarter 2014 operating earnings of $1.29 per share exceeded the Zacks Consensus Estimate of $1.13, thereby marking the sixth straight quarter of positive earnings surprise. The results were also higher than the year-ago quarter figure by 14.2%.

Although the third quarter is seasonally the weakest quarter, Aon’s earnings improved year over year on account of improved underlying operational performance and prudent capital management. In fact improved earnings along with investments in client servicing capabilities like the Global Risk Insight Platform and health care exchanges prompted management to expect stronger operating performance in the upcoming quarter as well thus delivering strong full-year earnings.

Including extraordinary items worth 25 cents per share, Aon’s net income per share was $1.04, comparing favorably with 82 cents in the year-ago period.

Total revenue of Aon went up 3% year over year to $2.9 billion on higher organic revenues (up 3% from the year-ago quarter). Revenues were in line with the Zacks Consensus Estimate.

Total operating expenses at the company were $2.5 billion, up 1% year over year. Higher expenses associated with organic revenue growth, initiatives to support future growth in the healthcare exchange business and an unfavorable impact from foreign currency translation mainly led to the deterioration. However, these negatives were partially offset by lower formal restructuring costs and intangible asset amortization as well as savings from the Aon Hewitt restructuring program.

Segment Update

Risk Solutions: Total revenue came in at $1.8 billion, up 1% over year. Organic growth of 1% in commissions and fees led to the improvement in revenues.

Adjusted operating earnings decreased 3% year over year to $372 million while adjusted operating margin decreased 80 basis points (bps) to 20.3% during the quarter. The deterioration was largely owing to an unfavorable impact from timing of some revenues and foreign currency translation, and one-time transaction costs.

Organic revenues at the Retail Brokerage segment increased 2% year over year. This resulted from higher organic revenues from the Americas business (up 2%), led mainly by business growth in Latin America and US Affinity. The improvement was also aided by growth in International organic revenues (up 2%), particularly in Asia and New Zealand, along with a robust renewal book portfolio in continental Europe.

Organic revenues at the Reinsurance segment decreased 4% mainly on the unfavorable market impact in treaty placements, decline in capital markets and transaction advisory business, and an unfavorable impact from some revenues. However, these were partially mitigated by growth in new businesses in treaty and facultative placements.

HR Solutions: Total revenue of $1.1 billion reflected an 8% year-over-year rise owing to 7% organic growth in commissions and fees and a favorable impact of 1% from foreign currency translation. Adjusted operating earnings increased 15% year over year to $174 million while adjusted operating margin improved 110 bps to 16.5%.

Organic revenues at Consulting Services improved 14% year over year owing to higher investment consulting, project work in retirement consulting and an expected favorable impact from revenue timings in compensation consulting.

Organic revenues at Outsourcing increased 3%, driven by the addition of new clients and project-related revenues in benefits administration.

Financial Position

As of Sep 30, 2014, cash and cash equivalents of Aon were $382 million, down 19.9% from $477 million as of Dec 31, 2013. Total assets of Aon as of Sep 30, 2014, were $28.8 billion, down from $30.3 billion at 2013-end.

Net operating cash flow came in at $883 million in the first nine months of 2014, down 10% year over year. This deterioration stemmed from higher receivable collections in the prior-year period and an increase in normal tax payments during the third quarter of 2014. Capital expenditure in the reported quarter increased 3% year over year to $179 million. Free cash flow in the first nine months was $704 million, down 13% year over year, due to lower cash flow from operations and higher capital expenditures.

Long-term debt increased to $4.8 billion as of Sep 30, 2014 from $3.7 billion as of Dec 31, 2013. Debt-to-capital ratio of Aon rose 830 bps from 2013-end to 43.3% as of Sep 30, 2014.

Share Repurchase Update

In the quarter under review, Aon bought back 5.8 million Class A Ordinary shares for nearly $500 million. The company is currently left with shares worth $1.1 billion remaining under its authorization.

Dividend Update

On Oct 13, 2014, the company’s board of directors declared a quarterly cash dividend of 25 cents per share that will be paid on Nov 14, 2014 to shareholders of record on Nov 3, 2014.

Our Take

Aon’s earnings surpassed the Zacks Consensus Estimate and improved year over year as well, primarily on improved underlying operational performance and prudent capital management. The improved operational efficiencies were fostered by the acquisition of National Flood Services in Jul 2014, which enhanced Aon’s capabilities as a flood insurance service provider. Moreover, the company’s efficient capital deployment is reflected in the share repurchases during the reported quarter as well as the increased dividend payouts owing to the dividend hike in second-quarter 2014.

Additionally, the company’s latest statement that more than 1.2 million employees, retirees and their eligible dependents from more than 100 companies will expectedly opt for individual and employer-sponsored health benefits through Aon’s health exchange suite is encouraging. We believe that realization of the same will increase Aon’s market share, thereby driving the share price as well.

Currently, Aon carries a Zacks Rank #3 (Hold).

Stocks to Consider

Some better-ranked stocks in the insurance brokerage space include eHealth, Inc. (EHTH), Erie Indemnity Company (ERIE) and Validus Holdings, Ltd. (VR). All three have a Zacks Rank #2 (Buy).

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