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Aon plc’s (AON - Analyst Report) second-quarter 2014 operating earnings of $1.25 per share exceeded the Zacks Consensus Estimate of $1.20, thereby marking the fifth straight quarter of positive earnings surprise. The results were also higher than the year-ago quarter earnings by 13%.

The upside was attributable to strong organic growth across both the segments, underlying operational improvement and efficient capital management.

Including 24 cents unfavorable impact of amortization of intangible assets, net income of $1.01 per share compared favorably with 76 cents per share in the year-ago period.

Total revenue of Aon went up 1% year over year to $2.9 billion on higher organic revenues (up 2% year over year), partly offset by an unfavorable impact from acquisitions, net of divestitures.

Total operating expenses at Aon were $2.5 billion, down 2% year over year. A decline in formal restructuring costs, acquisition-related expenses and intangible asset amortization mainly led to the improvement. However, 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 were setbacks.

Segment Update

Risk Solutions: Total revenue came in at $1.9 billion, flat year over year. Organic growth of 1% in commissions and fees was offset by a 1% decline in acquisition-related commissions and fees.

Adjusted operating earnings increased 1% year over year to $443 million while operating margin surged 20 basis points to 22.7% during the quarter. The improvement was driven by strong return on investments, cost containment measures and savings from the restructuring programs.  

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 new business generation across all regions. Growth in International organic revenues (up 3%), particularly in Asia and New Zealand, along with a robust renewal book portfolio in continental Europe also contributed to the improvement.

Organic revenues at the Reinsurance segment decreased 4% mainly on the unfavorable market impact in treaty placements and a decline in facultative payments. However, these were partially mitigated by an improvement in capital market transactions and advisory business as well as growth in new business in treaty placements worldwide.

HR Solutions: Total revenue of $982 million reflected a 3% year-over-year rise owing to 2% organic growth in commissions and fees, and a favorable impact of 1% from foreign currency translation. Adjusted operating earnings decreased 8% year over year to $130 million while operating margin declined 170 basis points to 13.2%.

Organic revenues at Consulting Services improved 1% year over year owing to higher investment consulting, partly offset by an expected unfavorable impact from timing in compensation consulting and deterioration in continental Europe.

Organic revenues at Outsourcing increased 3%, driven by new client acquisitions and project-related revenues in benefits administration.

Financial Position

As of Jun 30, 2014, cash and cash equivalents of Aon were $418 million, down 12.4% from $477 million as of Dec 31, 2013. Total assets of Aon as of Jun 30, 2014 were $31.8 billion, up from $30.3 billion at end-2013.

Net operating cash flow came in at $344 million in the quarter, up 3.3% year over year. Capital expenditure during the quarter declined 3.2% year over year to $60 million. Free cash flow in the reported quarter was $284 million, up 5% year over year, due to higher cash flow from operations and lower capital expenditures.

Long-term debt increased to $5.2 billion as of Jun 30, 2014 from $3.69 billion as of Dec 31, 2013. Debt-to-capital ratio of Aon increased 850 bps from 2013-end to 43.4% as of Jun 30, 2014.

Share Repurchase Update

In the quarter under review, Aon repurchased 7.4 million Class A Ordinary shares for nearly $650 million.

Dividend Update

On Apr 11, 2014, Aon increased its quarterly cash dividend by a significant 43%. In keeping with this hike, management declared a quarterly cash dividend of 25 cents per share, on Jul 14, 2014. The increased quarterly dividend will be paid on Aug 15, 2014, to shareholders of record as of Aug 1, 2014.

Our Take

Aon’s earnings surpassed the Zacks Consensus Estimate and improved on a year-over-year basis as well, primarily on segmental growth and capital management initiatives.

Further, the dividend hike during the quarter is likely to help Aon retain investors’ confidence. Moreover, the company’s strong fundamentals position it to generate consistent organic growth.

With Aon’s acquisition of StoneRiver National Flood Services, Inc. and related entities (National Flood Services) this month, it has strengthened business well. The latest acquisition will complement the company’s services by increasing its flood offerings and distribution.

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

Other Stocks to Consider

Some better-ranked stocks in the financial services space include Blue Capital Reinsurance Holdings Ltd. (BCRH - Snapshot Report), Alleghany Corp. (Y - Snapshot Report) and Endurance Specialty Holdings Ltd. (ENH - Snapshot Report). All three stocks sport a Zacks Rank #1 (Strong Buy).

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