$AJG Q2 2023 Earnings Call Transcript Summary

AJG

Jul 28, 2023

Arthur J. Gallagher & Company held their second quarter 2023 earnings conference call. J. Patrick Gallagher, Jr. introduced himself and the other members of the call. The company reported 20% revenue growth, 10.8% organic growth, and 13.4% organic growth if interest income was included. The company's CFO, Doug Howell, was also present on the call.

In the second quarter, the company reported GAAP earnings per share of $1.48, adjusted earnings per share of $2.28, up 21% year-over-year, and a reported net earnings margin of 13.6%, adjusted EBITDAC margin of 30.4%, up 52 basis points. The company also completed 15 mergers totaling $349 million of estimated annualized revenue. The brokerage segment had reported revenue growth of 20%, organic growth of 9.7%, and adjusted EBITDAC growth of 23% with expansive expansion of 50 basis points. Retail PC business posted 13% organic growth, UK PC business posted 11% organic growth, Canada was up 6% organically, and Global Employee Benefit Brokerage and Consulting business posted organic of about 2%.

In the second quarter of 2023, renewal premiums for primary insurance were up 12%, with increases across all major geographies and most product lines. Property premiums were up more than 20%, while general liability, workers comp, umbrella and package premiums were up 8%, 3%, 11%, and 11% respectively. The exceptions were public company D&O, where renewal premiums were lower, and cyber, which had flattened down slightly year-over-year. Despite this, the market remains rational, pushing for rate increases where necessary to generate an acceptable underwriting profit.

The second quarter of 2021 saw reinsurance renewals resulting in price increases due to the frequency and severity of weather events, replacement cost increases, and social inflation. Property reinsurance renewals saw the most hardening, especially in Florida, with increases ranging from 25-40%. Casualty reinsurance renewals were more stable, with prices increasing based on product or risk-specific factors. Despite these inflationary pressures, customer business activity remains strong with positive endorsements and audits continuing through July.

Gallagher Bassett had a strong second quarter, with 18.1% organic growth due to rising claim counts and new business wins. The HR consulting and benefits offerings are expected to remain strong due to the declining unemployment rate, increased non-farm payrolls, and the gap between job openings and unemployed people. The company completed 15 mergers in the second quarter, representing $349 million in annualized revenue, and has 55 term sheets signed or being prepared for future mergers, representing $700 million in annualized revenue.

Pat Gallagher, CEO of Gallagher, is proud of the company's success in the second quarter, with an adjusted EBITDAC margin of 19.4%. Gallagher's client base is diverse, ranging from large corporate enterprises to public entities, insurance carriers, and captives. The company is investing in its future by offering a two-month internship program, and Pat is confident that each new addition to the Gallagher team will uphold the company's values. Douglas Howell, CFO, will provide further details on organic growth, margins, cash, M&A capacity, and capital management.

The team had a fantastic quarter, leading to brokerage organic growth of 12% and contingents up 20% organically. Third quarter is expected to have headline brokerage organic of 9% and fourth quarter of 8% or 9% if accounting for a change in estimate from 2022. Adjusted EBITDAC margin was 32.1%, up 50 basis points from second quarter 2022 due to organic growth and interest income.

M&A, technology investments, and inflation on T&E have impacted Gallagher Basset's margins, resulting in 50 basis points of FX adjusted expansion in the quarter. For the year, the company is expecting a 30-40 basis points expansion in their margins. Risk management had an excellent finish to the second quarter with 18.1% organic growth, and margins of 19.4%. Going forward, Gallagher Basset is expecting double digit organic growth and margins approaching 20%, leading to a record year.

The earnings release for the corporate segment shows that adjusted second quarter results were in line with the June commentary, with a $5 million FX related re-measurement headwind. The outlook for the second half includes a modest weak corporate expense and interest in banking costs, and the company has $700 million in tax credit carry forwards to use over the next few years. The M&A revenues for the quarter totaled $151 million, with Buck contributing nearly half, and the company used a higher than normal amount of stock for tax free exchange mergers.

In the second quarter of 2023, the team had an outstanding performance with organic growth in brokerage of 200 basis points above what was expected. This was driven by the U.S. and U.K. markets, and the team feels confident that this performance will continue for the rest of the year with an adjusted organic growth rate of nine. J. Patrick Gallagher, Jr. then opened the call for questions.

J. Patrick Gallagher, Jr. and Weston Bloomer are discussing Gallagher's M&A strategy, with Gallagher noting that they have dozens of people doing deals and that they are constantly talking to competitors. Douglas Howell adds that potential sellers see their capabilities and that there is some concern about selling to a PE firm due to increasing interest rates and borrowing costs.

J. Patrick Gallagher, Jr. believes that 2024 will look a lot like 2023 in terms of organic growth in the brokerage business. He notes that underwriters are still asking for rate, but that cyber and D&O rates are coming down, while property rates are rising due to inflation and social implications. He also mentions that inflation has been talked about for over a year.

In 2024, Douglas Howell predicts that if the organic revenue growth is 6%, there will be 40-50 basis points of margin expansion. If the growth is 9%, the margin expansion could be 75-80 basis points. He also states that the Buck business runs a lower margin, so that will be a factor in the margin expansion.

Douglas Howell stated that investment income would lead to a 90 basis point margin expansion in the second quarter, 70 basis points in the third quarter, and 50 basis points in the fourth quarter. J. Patrick Gallagher, Jr. also commented that the market after January 1 was a bit more orderly, but still difficult.

J. Patrick Gallagher, Jr. is pleased with the success of the U.K. retail business, which he credits to branding and marketing efforts. He recently visited the London offices and noticed a bounce in the retailers' steps. Mike Zaremski then asked about the pricing environment and whether the reinsurance costs were being passed through, to which Gallagher responded that next year could be similar to this year, indicating that reinsurance costs were not a major factor.

Doug and Pat discuss the increasing cost base of carriers, the need to update values that have not been touched for a decade, and the cost of reinsurance. Pat then explains that there is no break in the market currently, and Greg Peters asks about the organic growth, existing clients versus new business, and if the balance has changed in the last year. Doug will provide numbers, and Pat will provide insight on how he sees the market shaping.

Douglas Howell and J. Patrick Gallagher, Jr. discuss the increased net new business versus loss business, which is up two percentage points from the previous year. Gallagher adds that they are doing a better job of measuring new business and that their average production and commission income have increased significantly. The goal is to have 15% of trailing revenue be from new business, and they are currently on track for that. Peters suggests tracking the net new business wins on a quarterly basis. Gallagher agrees and also mentions the importance of poking holes to make sure all the data is accurate.

Douglas Howell and J. Patrick Gallagher, Jr. discussed the employee benefits and MGA businesses, noting that the former is adjusted for large life case 5% and is in line with other brokers in the space, but may experience medical inflation soon. The MGA business may experience some stress due to changes in states or carriers, but is still performing well in the current environment. The clients are not looking to expand benefit offerings due to wage cost inflation.

J. Patrick Gallagher, Jr. is excited about the Buck integration, which has had a checkered past of success and challenges. He believes the outlook for the business is strong due to the management team being excited to have a home and the synergies that will be created. He also noted that GBS is doing their best to mitigate increased costs and benefits while balancing their employee base, as well as helping with plan design changes and getting fees for their work.

J. Patrick Gallagher Jr. is discussing the retention of clients and employees at his company following a period of ownership changes. He states that the onboarding process has been successful and that the orders they are receiving are very impressive. He also mentions that there are some great synergies between the company and its clients, and that there is no expectation of a huge acceleration in organic group benefits sales, which had a 5% growth rate in the first quarter.

Gallagher explains why they acquired Buck, even though it does not offer the same growth or margins as a PC broker. He states that they are in the business of pain mitigation for their clients, and that Buck is the best in the business when it comes to helping them manage their employees' benefits needs. He also mentions that Buck is often busier in the first quarter, as customers are putting the final touches on their programs.

J. Patrick Gallagher, Jr. and Douglas Howell discuss an acceleration in property and casualty rates, with general liability, workers comp, umbrella and package, and commercial auto increasing 8-11%, 8.5-10.5%, and 6-10.5% respectively. David Montemaden asks for clarification on the increases and they confirm the numbers.

J. Patrick Gallagher, Jr. and Douglas Howell discussed that property is Gallagher's largest line, making up 30% of their business for the full year 2022. Mark Hughes asked about medical inflation and J. Patrick Gallagher, Jr. and Douglas Howell mentioned that specialty drug costs and procedures have increased significantly. Katie Saki followed up with a question about the Buck acquisition and how it expands the business.

J. Patrick Gallagher, Jr. and Douglas Howell discuss the opportunity to improve the margins of the business by joining forces and taking the business from the upper teens to the mid 20s. They also see potential for cross selling opportunities between Gallagher Benefit Services and PC to Benefits, Benefits PC. They expect to see these improvements and cross selling opportunities in the first quarter of 2024.

Doug Howell explains that the nature of the business is that large clients can join in the fourth quarter, resulting in a sequential slow down in organic growth. However, the outlook for the year is still positive, with 13% organic growth expected. Additionally, there are larger clients on the drawing board that are being proposed to.

J. Patrick Gallagher, Jr. explains that Gallagher helps clients find solutions to untenable situations, such as finding them a pool to be part of, by-line by state, or putting them into a self-captive. He also explains that this is the genesis of their growth, and how it helped them become public in 1984. Meyer Shields then asks how much more clients can take in terms of affordability, and how this may affect the revenue from commissions.

Douglas Howell and J. Patrick Gallagher, Jr. discuss how customers can manage their insurance costs and premiums. They suggest that customers should take on more risk if their loss experience is bad, and that underwriters are happy to have clients move away from loss to them. Meyer Shields then asks about the reinsurance side, to which Gallagher states that their reinsurance people are the best in the world of capital management with their clients, and they are talking to sophisticated buyers.

J. Patrick Gallagher, Jr. and Douglas Howell of Gallagher Bassett discuss how they help clients manage their capital and mitigate medical cost inflation. They explain how they use managed care and expert adjusting services to reduce the total cost of risk. They also note that their M&A pipeline includes both P&C and employee benefits.

Douglas Howell states that Gallagher has been fair with their employees in terms of wage inflation, giving them larger raise pools for 2022 and 2023 than 2018 and 2019. He also mentions that they haven't yet planned for next year, but they will be fair with their employees.

Gallagher Bassett has seen a decrease in COVID claims and their existing customers' claims are flat-ish, with growth coming from new business and better retention. Severity has been increasing on average.

The speaker is asking about the company's M&A pipeline, which has been significant compared to recent quarters, and inquiring about the international versus domestic breakdown. The speaker also inquires about the renewal premium and is told that the July numbers are better than June numbers. Finally, the speaker asks about free cash flow in the second quarter and is told that it is the smallest quarter due to incentive compensation payouts.

J. Patrick Gallagher, Jr. expresses his appreciation to everyone who joined the call and discussed the company's second quarter performance. He is pleased with the improved financial outlook and the success of the company's people and culture. He looks forward to speaking with them again in September at the IR Day.

The conference call has ended and participants can now disconnect their lines.

This summary was generated with AI and may contain some inaccuracies.