Aon plc (NYSE:AON) Q4 2022 Earnings Call Transcript

Aon plc (NYSE:AON) Q4 2022 Earnings Call Transcript February 3, 2023

Operator: Good morning and thank you for holding. Welcome to Aon plc’s Fourth Quarter and Full Year 2022 Conference Call. I would like to also remind parties that this call is being recorded. If anyone has an 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 historic results or those anticipated. Information concerning risk factors that could cause such differences are described in the press release covering our fourth quarter and full year 2022 results as well as having been posted on our website. It is now my pleasure to turn the call over to Greg Case, CEO of Aon plc.

Greg Case: Thank you and good morning, everyone. Welcome to our fourth quarter conference call. I’m joined by Christa Davies, our CFO; and Eric Andersen, our President. As in previous quarters, for your reference, we posted a detailed financial presentation on our website. We begin today by thanking Aon colleagues around the world. Our strong performance in the fourth quarter and through 2022 and our strong momentum as we start 2023, continues to reflect tremendous dedication by our colleagues and the power of our Aon United strategy to support clients, both in their demands of today and as they plan to address their needs of tomorrow. 2022 was a year in which we continue to see clients focus on both the challenges and opportunities from increasing global risk and the opportunities to engage clients continues to grow.

In commercial risk, our latest weather climate and Catastrophe Insight report sized global economic losses from natural catastrophes at $313 billion, 4% over the 21st century average and it was only 42% covered by insurance, $190 billion protection gap. In Wealth Solutions, equity and fixed income market volatility in the back half of the year created demand for our Wealth Solutions colleagues to help organizations reassess retirement readiness and financial well-being. And in Health Solutions which includes our human capital business, the continuation of broad trends around a changing workforce, encompassing health, culture, wellness, engagement and inclusion, our growing and focus and importance across the C-suite and the stakes have never been higher.

In this environment of increasing risk and complexity across so many fronts, our colleagues are increasingly relying on Aon United. This would enable them to bring the full force of our firm, including core offerings and innovative solutions at scale to address evolving client demand. Turning to financial performance. In the fourth quarter, we delivered organic revenue growth of 5%, highlighted by 9% growth in reinsurance, 7% growth in Health Solutions and 6% growth in Wealth Solutions. In reinsurance, our teams were able to deliver strategic advice and data-driven analytics very early on in the renewal process to help clients navigate difficult market dynamics. This market leadership benefited our clients greatly in a challenging 1/1 renewal and reflects our strong performance.

In Health Solutions, we saw strength in our core H&P and human capital. Both of which benefited from enhancements to our offerings, tools and platforms and increased client focus on employee health, rewards, engagement in well-being. In Wealth Solutions, our team delivered the strongest quarterly organic revenue growth in over 5 years. As our teams worked tirelessly to respond to client demand resulting from market and interest rate volatility, particularly in the U.K. and continue to help clients execute on pension risk transfer, strategic pension management and respond to regulatory changes. And finally, commercial risk grew 4% in the quarter and 6% for the year. We delivered double-digit organic revenue growth in Canada and Latin America and strong growth in Europe, the U.K. and Asia Pacific.

In the U.S., otherwise strong results continue to reflect the impact of the external M&A and IPO environment on M&A services. This impact reduced quarterly organic growth by 5%, an annual growth by 2.5%. And while this short-term pressure may continue into Q1, over the long term, we are very well positioned in this highly attractive business but has significant opportunity to contribute to long-term top and bottom line growth. For the full year, our organic revenue growth of 6% is a direct result of our Aon United strategy and is a key driver of strong top and bottom line results for the full year. Noting adjusted operating margins expanded 70 basis points to 30.8%. Adjusted earnings per share grew 12% to $13.39, overcoming a 3% or $0.44 FX headwind.

Free cash flow exceeded $3 billion with free cash flow margins of 24.2%, both our highest ever and we completed $3.2 billion of share buyback, demonstrating our confidence in the long-term value of the firm. Our team’s performance positions us exceptionally well to deliver in 2023 and over the long term. Looking back, since 2010, we’ve reported 4% average organic revenue growth. Over 1,100 basis points of margin expansion or about 90 basis points per year, while adjusted EPS and free cash flow increased at a compound annual growth rates of 12% and 13%, respectively. More important, we view the go-forward opportunity and momentum higher now than any time in our history. Looking ahead, we continue to expect mid-single-digit or greater organic revenue growth for the firm, margin improvement and double-digit free cash flow growth for the full year 2023 and over the long term.

Reflecting on the year, we would offer a few observations on how Aon United continues to deliver for clients. The steps we’ve taken over the past decade, including our single brand and single P&L, put us in an exceptionally strong position to deliver for clients and have significant impact on some of the greatest opportunities and challenges they face. These ideas are not new. There are a continuation of over a decade of progress on the areas highlighted in our Aon United blueprint, clients, colleagues, innovation at scale and Aon business services that are increasingly interconnected and mutually reinforcing. On delivering innovation at scale, the platform we’ve built not only enables innovation of new concepts as we’ve demonstrated in areas like intellectual property solutions and climate but increasingly enables us to bring together our analytics and expertise for new solution development, both from within solution lines and connected across our business.

For example, our Health Solutions team has developed an Aon health analytics platform, supported by hundreds of data scientists and credential health actuaries, as well as experts from human capital and ad business services. It’s designed to help clients assess and improve their employees’ health which in turn helps deliver well-being, productivity and lower cost. Within this offering, driven by proprietary analytics, we can assess data around employee health information, insurance and claims, workplace safety, absence engagement data and external data on health trends and solutions which together form a robust view of employee physical well-being. With this insight, our teams can recommend individualized solutions, including better insurance offerings and targeted program.

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As an example, 1 manufacturing client wanted to improve employee physical well-being and reduce costs. Together, we designed a comprehensive long-term well-being strategy and a customized health program that includes 12 vendors and targeted specific health and well-being programs for employees based on individual factors correlated success. The results were impressive. In our target group as compared to nonparticipants, we saw meaningful improvement in selected health metrics at 24% lower cost per person. Further, the platform allows for rapid scale and distribution of a solution to help our clients drive workforce health, wealth and productivity. Equally important, our colleagues while having this kind of impact which is an important driver of our very high Aon colleague engagement.

And we see examples like this across the firm every day as we help our clients manage risk and support their people. And this demonstrates the opportunity to continue delivering innovative solutions at scale to address our clients’ biggest challenges across the backdrop of rapid change and ongoing volatility. To summarize, we began 2023 in a position of strength. Our firm is more connected than ever before, enabling us to deliver better solutions for clients and to better support our colleagues. Aon United will continue to deliver results now and over the long term for our clients, colleagues and shareholders and is reflected in our progress to achieve key financial objectives. Now, I’d like to turn the call over to Christa for her thoughts on our financial progress in Q4 and 2022 and our long-term outlook.

Christa?

Christa Davies: Thanks so much, Greg and good morning, everyone. As Greg highlighted, we delivered another strong quarter of performance across our key metrics to finish the year. In the quarter, we translated 5% organic revenue growth into 40 basis points of adjusted margin expansion and strong growth in adjusted earnings per share. For the full year 2022, organic revenue growth was 6%. Adjusted operating margins increased 70 basis points to 30.8% and we generated over $3 billion in free cash flow, an all-time high. We look forward to building on this momentum as we head into 2023. As I reflect on results, as Greg noted, organic revenue growth was 5% in the fourth quarter and 6% for the full year. We continue to expect mid-single digital greater organic revenue growth for the full year 2023 and over the long term.

I would also note that reported revenue growth of 2% in both Q4 and the full year includes an unfavorable impact from changes in FX of 4% in both periods. Primarily driven by a stronger U.S. dollar versus most currencies. I’d also highlight that fiduciary investment income which is not included in our organic revenue growth, was $41 million in Q4 and $76 million for the full year or 1% in both periods. Moving to operating performance. We delivered strong operational improvement in Q4 with adjusted operating margins of 33.2% an increase of 40 basis points driven by organic revenue growth and efficiencies from Aon Business Services, overcoming expense growth, including investments in colleagues and technology to drive long-term growth and some ongoing resumption of T&E.

For the full year, adjusted operating margin of 30.8% reflects margin expansion of 70 basis points year-over-year. And I’ll note over the past 12 years, we delivered 90 basis points of margin expansion a year. Looking forward, we expect to deliver margin expansion in 2023 and over the long term as we continue our track record of cost discipline and managing investments in long-term growth on an ROIC basis. As we’ve previously communicated, we think about margins over the course of the full year, driven by 3 areas: the first is top line revenue growth. The second is this portfolio mix shift to higher margin businesses as we invest disproportionately in areas of increasing client demand, supported by data-driven solutions to deliver the insights and advice that help our clients protect and grow their organizations.

And third area is increased operating leverage from ongoing productivity improvement from our Aon Business Services platform. I’d highlight that Aon Business Services continues to be a key contributor to margin expansion and represents a competitive advantage, especially in a high inflationary market. Our Am business services platform continues to drive efficiency gains, improved quality and service and increased innovation at scale. During 2022, we continue to make progress on Aon Business Services and driving efficiencies in enhanced services. Particularly through process improvement, automation and the use of artificial intelligence. For instance, our captives business has clients with hundreds of legal entities who each require multiple policies.

Previously, the process of checking policies was manual and inefficient. We’ve now moved to a digital solution that can identify differences quickly and accurately and deliver these to clients much more quickly. Similarly, the use of AI is increasingly enabling us to deliver better solutions to clients. For example, we delivered a new solution for our human capital clients using an AI-powered search engine that provides them with insights on technology talent globally including geography-based pay differentials. This is essential for finding the best technology talent and optimizing within the client’s existing workforce, a key area of growth for many firms. As we’ve said before, these improvements not only improve accuracy and client service delivery, they also help free up our colleagues time for more valuable client activities and drive better outcomes for our clients.

Organic growth and margin expansion translated into adjusted EPS of 5% in Q4 and double-digit growth of 12% for the full year. As noted in our earnings materials, FX translation was an unfavorable impact of approximately $0.09 per share in Q4 and $0.44 per share for the full year 2022. If currencies are remained stable at today’s rate, we would expect an unfavorable impact of approximately $0.13 per share in the first quarter of 2023 and $0.12 per share for the full year 2023. Turning to free cash flow and capital allocation. We generated over $3 billion in free cash flow in 2022, contributing to our long-term track record of growing free cash flow at 13% CAGR since 2010. Our outlook for free cash flow in 2023 and beyond remains strong and we continue to expect to deliver double-digit free cash flow growth for the full year and over the long term, driven by operating income growth and working capital improvements.

I’d note CapEx returned to a more normalized level in 2022 as we made ongoing investments in ABS enabled platforms and technology to drive long-term growth. As we’ve said before, we manage CapEx like all of our investments, on a disciplined return on capital basis. Given our strong outlook for free cash flow growth in 2023 and beyond, we expect share repurchases to continue to remain our highest ROIC opportunity for capital allocation. We believe we’re significantly undervalued in the market today, highlighted by the approximately $675 million of share repurchases in the quarter and $3.2 billion of share repurchase for the full year. We also expect to continue to invest organically and inorganically in content and capabilities that we can scale to address unmet client needs.

We’ve invested in expertise and content to help meet our clients’ needs such as our Q4 acquisition of ERM, a Mexico-based leader in risk assessment modeling which expands our catastrophe modeling and consulting capabilities in reinsurance. Our M&A pipeline continues to be focused on our highest priority areas that will bring scalable solutions to our clients’ growing and evolving challenges. We will continue to actively manage the portfolio and assess all capital allocation decisions on an ROIC basis. We ended 2022 with an ROIC of 30.6%, an increase of nearly 1,900 basis points over the last 12 years. Now turning to our balance sheet and debt capacity. We remain confident in the strength of our balance sheet and manage liquidity risk through a well-laddered debt maturity profile.

We expect to add incremental debt as EBITDA growth over the long term while maintaining our current investment-grade credit ratings. With respect to interest rates, I’d note our term debt is all fixed rate, with a weighted average interest rate of approximately 4% and a weighted average maturity of approximately 12 years. I’d note our pension liability improved as interest rates increase. As a continuation of our pension derisking efforts, I’d highlight that we completed an annuity settlement transaction in the fourth quarter, resulting in approximately $300 million reduction in our pension benefit obligation. This continues to be an incredibly attractive environment for our clients to do pension risk transfers and we continue to see very strong demand from clients.

We’ve done substantial numbers of pension risk transfers in the U.S. and the U.K. and are a leader in the space. In summary, 2022 was another year of strong top and bottom line performance, driven by the strength of our Aon United Strategy and Aon Business Services. We returned over $3.6 billion to shareholders through share repurchase and dividends. The success we achieved this year continues to provide momentum as we head into 2023. While we’re seeing signs of economic uncertainty, we remain confident in the strength of our firm and our financial guidance for 2023. Overall, our business is resilient and our Aon United strategy gives us confidence in our ability to deliver results in any economic scenario. With that, I’ll turn the call back over to the operator and we’d be delighted to take your questions.

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Q&A Session

Operator: Thank you. At this time, we’ll be conducting a question-and-answer session. Our first question comes from the line of Elyse Greenspan with Wells Fargo.

Elyse Greenspan: My first question is on your margins. So if we look in the quarter, it seems like your margin declined excluding the benefit of fiduciary investment income. So I’m just trying to get a sense of the drivers and outlook you see for your margin, excluding the NII benefit in 2023?

Christa Davies: Yes. Thanks so much for the question, Elyse. That is correct. We saw 40 basis points of margin expansion and 90 basis points of impact from fiduciary investment income. And I would note, we really think about margins over the course of the full year. So 70 basis points of margin expansion in the full year, of which 40 basis points came from fiduciary investment income. And we really think about margin expansion over the long term. Our margin growth has been 1,120 basis points over the last 12 years or 90 basis points a year for 12 years. And it’s really driven by revenue growth, the portfolio mix shift to higher margin areas and the productivity benefit we’re getting from Aon Business Services. And so we’re extremely confident with that track record at least for our financial guidance which is mid-single-digit or greater organic revenue growth, margin expansion for the full year 2023 and double-digit free cash flow growth for the full year 2023.

Elyse Greenspan: So assuming we continue to get a tailwind from fiduciary investment income, I guess, in ’23, you’ll probably balance letting that all fall to the bottom line and making some of the investments similar to what you did in the fourth quarter?

Christa Davies: I think that’s fair. We are continuing to drive margin expansion each and every year, overcoming investments we’re making in the business because you saw in Q4 we substantially invested in IT. So our IT expense is up. We’re investing in platforms and technology to drive innovative solutions for clients. And we’ll continue to invest in our colleagues and we’ll continue to invest in M&A and we’ll continue to invest in a lot of areas to drive long-term growth but we really think about this over the course of a full year which is really what matters to us.

Elyse Greenspan: And then my second question, we’ve heard a lot about a lot of strong pricing coming out of the January 1 reinsurance renewals. Can you give us a sense of the outlook for your reinsurance business? I am not sure if you highlighted it in the past but the concentration is in the property lines. But can you give us a sense of just how you think that business should perform in an environment where we’re seeing as robust catastrophe reinsurance price increases that we saw at January 1?

Eric Andersen: This is Eric Andersen, why don’t I take that one to kick us off. It’s great to be with you this morning. The reinsurance business continues to be a very strong performer for us as we go through the year. And I would say certainly, a lot of attention spent on property CAT for good reason. Certainly, the losses, the interest rate moves, the restructurings of the programs that were happening throughout the season. I would say Property CAT continues to be a dominant part of the business but it’s not the whole business. Certainly, casualty, specialty and others continue to be a big part of it. But so I would say, as I think through the future of what’s going to happen over the next 12 months, we continue to see a very robust opportunity for the team.