Aon plc (NYSE:AON) Q1 2024 Earnings Call Transcript

Aon plc (NYSE:AON) Q1 2024 Earnings Call Transcript April 26, 2024

Aon plc misses on earnings expectations. Reported EPS is $5.66 EPS, expectations were $5.86. AON isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and thank you for holding. Welcome to Aon plc’s First Quarter 2024 Conference Call. At this time, all parties will be in a listen-only mode until the question-and-answer portion of today’s call. I would also like to remind all parties that this call is being recorded. If anyone has any objection, you may disconnect your line at this time. It is important to note that some of the comments in today’s call may constitute certain statements that are forward looking in nature as defined by the Private Securities Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. Information concerning risk factors that could cause such differences are described in the press conference covering our first quarter 2024 results, as well as having been posted on our website.

Now, it is my pleasure to turn the call over to Greg Case, CEO of Aon plc.

Greg Case: Good morning, everyone, and welcome to our first quarter conference call. I’m joined by Christa Davies, our CFO, and Eric Andersen, our President. For your convenience, we posted a detailed financial presentation on our website. As always, we begin by thanking our colleagues around the world for the incredible work they do every day to support each other and deliver the best of our firm to clients. And this quarter, I also want to single out one colleague in particular, our Chief Financial Officer and my friend and partner, Christa Davies. As you know, Christa announced her retirement from her role as CFO earlier this month, following over 16 years of tremendous service. With Christa’s guidance, we developed a seamless transition plan.

As previously announced, Christa remains in our CFO role in the second quarter earnings and we’re making strong progress against well-defined plans to have her successor in place to begin the handoff. I’m grateful that you’ll continue to serve as a senior advisor into 2025 to ensure great continuity. Now to begin our report today, it’s important we start by highlighting an incredibly exciting milestone for our firm, the completion of our work to bring NFP into the Aon family as we closed the transaction yesterday. To the 7,700 NFP colleagues, who now join our firm, welcome to Aon. NFP’s client relationships, capabilities, focused sales force, and market knowledge provides a meaningfully expanded position in the fast-growing $31 billion North American middle market.

Since our announcement late December, we’ve gotten to know the team even better and our appreciation and excitement for what we can do together has continued to grow and the opportunity is even more clear. In Commercial Risk, complementary specialist resources and expertise from both organizations will enhance what we bring to clients. Delivering Aon’s analytics and decision support tools to the NFP sales force allows for real differentiation on top of their highly-integrated sales approach. Further, we can reintroduce and introduce, reinforce NFP’s offerings with access to our programs and facilities like Aon Client Treaty, and also in Commercial Risk, we can leverage our global Aon network for clients who require seamless global service to enhance an already strong NFP value proposition.

In Wealth Solutions, we see great opportunity to bring our capabilities around pension risk transfer to NFP clients, as well as to continue to build on our investment offerings together, ensuring all clients have access to retirement options that best support their people. And in Health Solutions, our businesses are highly complementary with new opportunities in the health value chain where we don’t operate today, or for clients that we only serve in one solution line. And for example, NFP brings outstanding health value proposition for clients with under 100 employees, an attractive option for our smaller clients in Commercial Risk. Conversely, we see great opportunity to provide NFP’s clients with our data and analytics solutions, including benchmarking and tools on health equity, network strategies, and high-cost claimants.

Further, we can support current NFP clients with specialized capabilities in areas such as global benefits, pharmacy consulting and consumer benefits. Another great strength of NFP is their exceptional M&A engine and very strong acquisition pipeline as we look to the future. On deal financials, we’re delighted to close much earlier than originally modeled with fewer shares issued and realization of benefits that now occur a year earlier. Noting, we now expect EPS accretion to ’26 and thereafter and additional free cash flow of $300 million and $600 million in 2025 and 2026, respectively. We’re incredibly excited about the opportunity as we bring Aon and NFP content capabilities together, enabled by Aon Business Services. We also see great value in the operating model built around the principle of independent and connected to deliver Risk Capital and Human Capital capability to our clients.

All in, this acquisition is another strong step forward in our Aon United journey and reinforces our long-term financial guidance to deliver mid-single digit or greater organic revenue growth, adjusted operating margin expansion and double-digit free cash flow growth over the long term. Turning now to our results in the quarter. Overall, our team delivered a strong start to the year with 5% overall organic revenue growth, 100 basis points of adjusted margin expansion and 9% EPS growth. Within our solution lines, Reinsurance delivered 7% organic revenue growth, as our team helped clients navigate continued market challenges, but with greater capacity and stable pricing on programs. Further, our team is increasingly building on traditional capabilities with enhanced data, analytics and advisory capabilities.

In Health Solutions, we delivered 6% organic revenue growth with strong growth in core health across all major geographies, driven by strong ongoing new business generation and retention and strength in specialist capabilities like consumer and pharmacy benefits. In Wealth Solutions, organic revenue growth of 4% reflected strength in retirement as our teams continue to help clients reduce risk through pension risk transfer and manage the ongoing impact of regulatory changes as we continue to bring leading capabilities to help clients match risk and capital. In Commercial Risk, we saw 3% organic revenue growth, highlighted by strength in Asia and the Pacific, Continental Europe and areas in our portfolio like construction. As we look at these results, especially in the U.S., we’ve seen the impact of our business mix play out, as we have strength and strong weighting in larger clients and specialty lines like D&O.

These are significant areas within our U.S. Business and again areas where we’re strong and we see substantial long-term top- and bottom-line growth potential despite some current pressure reflected in net new business. Going forward, we’ll continue to be strong in these categories and continue hiring and investment in priority areas like energy and construction. We also observed, as we’ve mentioned previously, we’re not seeing a real rebound yet in M&A and IPO activity, though we know there’s demand and dry powder building. And until yesterday, we were relatively smaller in a $31 billion North American middle market, although now with the close of NFP, we’ve added 7,700 colleagues and established a much more meaningful position in this fast-growing market.

Overall, across the firm, we continue to focus on our most critical asset, our talent. Our engagement remains at historically high levels, and our voluntary attrition in Q1 is at the lowest level in many years. On talent acquisition, we continue to increase hiring in selected client-facing areas, as well as an analytics capability to support our efforts in Risk Capital and Human Capital. In summary, we’re making great progress to start the year. Our first quarter results and the close of NFP put us in a strong position to continue delivering results through 2024 and over the long term. This progress fully reinforces our 3×3 plan, focused on three fundamental commitments over the next three years, including capitalizing on our work in Risk Capital and Human Capital, delivering Aon client leadership, and amplifying these efforts through Aon Business Services.

The strength, importance and momentum of this plan is being strongly reinforced by ongoing client and colleague feedback. And this plan defines a powerful path forward, one that drives ongoing top- and bottom-line growth and greater levels of long-term free cash flow growth, exactly consistent with our ongoing financial guidance. Finally, as I turn the call over to Christa, I want to return to my opening comments and thank her again for her partnership, leadership, and friendship. Ultimately, Christa will have left a permanent imprint on our Aon United strategy. For 16 years, our shared mission has been to connect our colleagues to a “one firm” mindset so they can deliver more value to clients. That mission is universally focused on accelerating Aon United, and now, in arguably our most exciting period, it’s fully reflected in our 3×3 plan, and Christa has been a critical partner in all of this work.

Our Aon colleagues will miss Christa in the CFO role. Personally, the journey with Christa is a highlight of my professional career. Our 52,000 colleagues, and as of today, 60,000 and their families are in a better position because of Christa. We’re all grateful that Christa will be staying with us as a senior advisor to continue to drive momentum as she moves on to her next mission. And most important, we fully appreciate that there are other missions in life of higher priority, and we embrace Christa’s decision to shift her focus at this time. Christa, my friend, over to you.

Christa Davies: Thank you so much, Greg. I want to start by thanking you for the opportunity over the last 16 years to contribute to the incredible success we’ve had at Aon. This will be the defining role of my career, and that’s really what’s at the heart of this decision. As you described, this decision isn’t about other professional pursuits. My decision is to focus my time differently at this point in my life. I’m grateful that our work together has created the ability for me to make this choice. I must say that our 3×3 plan delivers on its full potential in the months ahead, including with the great addition of NFP. I’m going to truly miss working so closely with this team to realize the tremendous value creation that is ahead for Aon.

We’re also very pleased to announce the completion of the NFP acquisition. I’m delighted to welcome the NFP to Aon. We’re excited to work together to capture the growth opportunities we see for clients, colleagues, and shareholders. As we announced yesterday, we closed the transaction for a total enterprise value of $13 billion. The faster-than-expected close date means we now expect to achieve a similar benefit a year earlier with improvements in certain metrics. Noting, we maintained guidance for revenue and cost synergies of $235 million, which now occur a year earlier given the close date. We achieved a lower interest rate on deal-related debt of 5.7%, and we issued fewer shares at 19 million. Collectively, this results in similar deal-related financial benefits of accretion and free cash flow that are realized a year earlier than initially modeled.

We now expect the deal to add $300 million to free cash flow in 2025 and $600 million in 2026, and be accretive in 2026 and over the long term. We’ve also provided detailed financial information for NFP in our materials. NFP built on our long-term proven track record of strategically allocating capital at scale to high-return opportunities to create long-term value for clients, colleagues, and shareholders. And as Greg mentioned, it reinforces and accelerates our Aon United strategy and our 3×3 plan, and adds to our strong momentum as we drive results in 2024 and over the long term. Now turning to the quarter. We delivered strong operational performance to start the year, highlighted by 5% organic revenue growth, which translated into 100 basis points of adjusted operating margin expansion, 8% adjusted operating income growth, and 9% adjusted EPS growth.

As Greg noted, organic revenue growth was 5%, driven by ongoing strong retention and net new business generation. I’d note that fiduciary investment income, which is not included in organic revenue growth, was $79 million. If you were to include fiduciary investment income, organic revenue growth would have been 70 basis points higher. We continue to expect mid-single digit or greater organic revenue growth for the full year 2024 and over the long term. And as we look forward, we continue to expect that NFP will contribute to the firm’s overall revenue growth through organic revenue growth, including $175 million of net revenue synergies by 2026 and inorganic growth from ongoing M&A. Moving to operating performance. We delivered strong operational improvement in Q1 with adjusted operating margins of 39.7%, an increase of 100 basis points, driven by revenue growth, portfolio mix shift, efficiencies from Aon Business Services, and restructuring savings, overcoming expense growth, including investments in colleagues and technology, to drive long-term growth.

Restructuring savings in Q1 were $20 million and contributed 50 basis points to adjusted operating margin expansion. Restructuring actions completed so far are expected to generate $90 million of savings in 2024, and we expect restructuring savings will fall to the bottom-line. At this time, we continue to expect $100 million of realized savings in 2024 as we continue to execute against our plans for Aon Business Services and our business. Regarding the program, we are seeing real progress in our acceleration of Aon Business Services. This includes streamlining and improving operational processes around working capital, moving work to the best locations, and enhancing clients’ and colleagues’ experience with great new tools such as our property, casualty, D&O, and cyber analyzers.

As we’ve said previously, we know delivering our Aon Business Services strategy will result in long-term top- and bottom-line growth as we drive more value for clients, colleagues, and shareholders. As we think about adjusted operating margins going forward, we continue to expect to drive margin expansion over the long term through ongoing revenue growth and portfolio mix shift to higher growth, higher margin areas of the portfolio, driven by efficiencies from Aon Business Services. Now that we’ve closed NFP, margins will be initially lower. Considering the close timing, we think the right baseline from which to measure 2024 adjusted operating margin growth is 30.6%, calculated as our 31.6% in 2023, less a 100 basis point drag from NFP for the period from April 25th close through the end of 2024.

In our materials, we’ve detailed 2023 operating performance for NFP. On a full year basis, we would note that NFP would have had a full year pro forma drag of a 140 basis points for 2023, so there’ll be some ongoing drag on 2025 margins until we lap the close in April 2025. We also expect fiduciary investment income to be relatively flat year-over-year based on current interest rate expectations. So, the tailwind that we’ve seen in Q1 this year will be reduced, although we remain committed to driving full year adjusted operating margin expansion in 2024 against this adjusted baseline of 30.6% and over the long term. Turning to EPS, adjusted EPS grew 9% in the quarter, reflecting 8% adjusted operating income growth and ongoing share buyback, partially offset by a higher tax rate in the quarter.

With respect to NFP, as we previously communicated, we expect the acquisition to be dilutive to adjusted EPS in the remainder of 2024, breakeven in 2025, and accretive to adjusted EPS in 2026 and beyond. Turning to free cash flow. I’d note Q1 has historically been our seasonally smallest quarter from a cash flow standpoint due primarily to incentive compensation payments. And as we’ve communicated before, free cash flow can be lumpy quarter to quarter. We generated $261 million of free cash flow in the first quarter, reflecting strong operating income growth and lower CapEx, offset by higher receivables, payments related to E&O, restructuring, NFP transaction integration charges, and higher cash tax payments, as we’ve previously communicated.

As we look forward, we expect ongoing negative impacts of free cash flow in the near term from restructuring, higher interest expense, and NFP deal and integration costs. The NFP acquisition strengthens our long-term free cash flow outlook with $300 million of incremental free cash flow in 2025 and $600 million in 2026. Over the long term, we would expect to return to our trajectory of double-digit free cash flow growth, driven by operating income growth and a $500 million opportunity in working capital. Now turning to capital allocation. We allocate capital based on return on capital and a long-term value creation, which we’ve done over time through core business investment, share buyback, and M&A. Regarding M&A, as you look historically, we have a successful track record of balancing acquisitions, divestitures, and share buyback as we continue to optimize our portfolio against our priority investment areas on an ROIC basis.

We’re incredibly excited about NFP’s impressive M&A engine, noting their strong history of M&A. We look forward to building on their established track record and executing against their strong pipeline to drive future growth in this space within our ROIC framework. We still expect share buyback to remain the top priority for capital allocation. As we think about capital allocation in 2024, we’d observe there are puts and takes around free cash flow that we’ve communicated. And while buyback will be lower than last year, we expect it will still be substantial at $1 billion or more based on our current M&A expectations for the rest of the year. We have a very strong long-term free cash flow outlook for the firm and are confident that share repurchase will continue to remain our highest ROIC opportunity for meaningful ongoing capital allocation over time.

Turning now to our balance sheet and debt capacity. We remain confident in the strength of our balance sheet. As previously communicated, we funded the cash and assumed liabilities portion of the NFP purchase with approximately $7 billion of new debt, with $5 billion raised in March 2024, and $2 billion borrowed at close. And I’d note, the average interest rate for the $5 billion of transaction related senior notes and the $2 billion term loan is 5.7%, about 80 basis points better than what we modeled when we announced the deal. We expect our credit ratios to be elevated over the next 12 to 18 months as we bring our leverage ratios back in line with levels consistent with our credit profile, 2.8 times to 3 times debt to EBITDA on a GAAP basis.

This is driven by substantial free cash flow generation and incremental debt capacity from EBITDA growth, noting our track record of effectively managing leverage within current ratings. In summary, our operating performance in Q1 is a strong start to the year, and we’re well positioned to build on this momentum in the rest of the year. We’re delighted to have closed NFP acquisition ahead of schedule, enabling us to achieve financial benefits of accretion and free cash flow a year earlier than initially modeled. We look forward to enhancing NFP’s strong client relationships with Aon’s content and capabilities and see real opportunity to learn from each other and bring better solutions to our clients together. It’s another step forward in our 3×3 plan as we accelerate our Aon United strategy, catalyzed by Aon Business Services and reinforced by the restructuring program.

With that, I’ll turn the call back to the operator, and we’d be delighted to take your questions.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Andrew Kligerman with TD Securities. Please proceed with your question.

Andrew Kligerman: Thank you. Good morning, and congratulations, Christa. Greg, you mentioned in the opening remarks the lowest attrition that Aon has seen in a while. Could you put any details around that? Any color? It sounds very interesting.

Greg Case: Well, Andrew, I appreciate the question. Listen, if you step back and think about sort of talent overall and what we’re about and what we’re up to, this is really about how we’ve built on Aon United and the strategy around the culture, and it’s been foundational, how we connect our colleagues, support each other, and deliver the best we can for our clients. And that has just continued to build, and it really gives them an opportunity to sit across the table to do some pretty unique things with clients, which is why they’re here, why they’re excited about being part of our firm. And then on top of that now, we’ve got the 3×3 plan, Andrew, which literally is going to continue to enhance this very substantially with greater content and capability in Risk Capital and Human Capital, as well as the analytics that underpin all that driven by ABS.

So, for all those reasons, this is a pretty unique place to be at a time when clients have high need. But, Eric, what else would you add to that?

Eric Andersen: Yeah. Greg, maybe I’ll just take it down. If you’re an account leader or a colleague working with a client, just picking up on your example, culture capabilities, team support, all those drive a decision to either come or stay at our firm. And if you just think about it, historically, if you were part of a client team, you were having a product discussion with a client. Today, you’re having — if it’s a risk client, you’re having a risk capital discussion. So, you’re having colleagues from commercial risk, from [re] (ph), maybe captives, maybe risk consulting, using new tools, like, at the risk analyzers that Christa mentioned, that are created with our ABS colleagues. It creates a professional development for them, and it creates a team-based environment where you’re actually providing real new value to clients. So, I think all of that drives why people come and then ultimately why they stay with us.

Andrew Kligerman: Awesome. And then just shifting over to the tax rate, around 23% this quarter, it’s a bit surprising just given that over the last several years, it’s kind of hovered around 18.5%. And I know Christa doesn’t give guidance on this, but maybe given the big move in the tax rate and your points in the write up about changing geography, you could give us a little color on, A, the change in geography of the tax? And B, maybe an exception and an indication of where we might expect the tax rate to be going forward, especially with NFP there?

Christa Davies: Thanks so much for the question, Andrew. And we did see a higher tax rate this quarter, driven by, as you said, changes in the geographic distribution of income and unfavorable discretes. And I will note, Andrew, that discretes have historically been positive for us, and in this quarter, they really did just line up to be net negative. And what I would say is, look, it’s just lumpy to quarter to quarter. And, as you said, we don’t give guidance going forward. But if we look back historically, exclusive of the impacts of discretes, which can be positive or negative, our historical underlying rate for the last five years has been 18%.

Andrew Kligerman: Okay. Thank you very much.

Operator: Our next question is from Jimmy Bhullar with JPMorgan. Please proceed with your question.

Jimmy Bhullar: Good morning. So, first just had a question on organic growth in Commercial Risk. If we look over the past year, year-and-a-half or so, it seems to have lagged what we’ve seen at some of your peers. And initially, I think a lot of people were concerned that this was because of the fallout from Willis. You’ve highlighted, the capital markets activity pressuring your results more than peers as well. But wondering if you could just talk about why you feel your growth has lagged some of your large peers even though historically you’ve actually been fairly consistent with growth with most of the other competitors?

Greg Case: Jimmy, really appreciate the question. And maybe what I’ll do is I’ll step back and just again orient overall for global Aon, how we think about the firm and how we think about progress over time. And if you step back, we’d essentially say, first of all, this is not about one quarter, it really is about as you look across over the year, kind of how we’re performing across global Aon over the course of the year. And our mission right now, which we’re going to continue to push on and really amplify is to build on the 3×3 plan over the next three years. And this is really capitalizing on Risk Capital and Human Capital, amplifying through Aon Business Services and delivering Aon client leadership, which we know, Jimmy, is going to together deliver both top-line and bottom-line performance and most important the double-digit annual free cash flow growth compared to our ’23 baseline that Christa described.

And if you think about the quarter, which you’re coming back to now asking specifically, I’m going to get to Commercial Risk very explicitly in a second, but our goals in the quarter from our standpoint were actually accelerated in terms of that 3×3 plan. If you think about ABS, the introduction of our analyzers and the client experience improvements, client response has been exceptional and real progress in the quarter. Our restructuring plan, as Christa highlighted, strengthens really what we’ve done in ABS substantially and it really supports substantial hiring in priority areas. So, all good from a priority standpoint, and obviously, of course, the announcement of NFP with truly game-changer access into the North American middle market, and really every — think about all aspects or generally aspects of the close improved since our December 20th announcement.

So, if we step back, Jimmy, and you sort of say, how are we doing from our standpoint, we feel very good, especially about the 3×3 plan and the progress we made on it. And if you think about the quarter overall for Aon, we delivered mid-single digit growth 5% with strength in Health and Reinsurance in Continental Europe and Asia and the Pacific, margin expansion of 100 basis points, EPS growth of 9% and free cash flow exactly in line with expectations. And then specifically to your question, because I want to make sure I get to that, look, we saw strength in Commercial across Continental Europe, Asia and Pacific, all very good. We highlighted the mix play, as we think about where we really have large portions of our business weighted to our larger clients, especially in some of the specialty lines like D&O and there’s some pressure there, but we also observed, obviously as we just described, we were very underweight in the fast-growing middle market until yesterday.