We have reiterated our Neutral recommendation on Marsh & McLennan Cos. Inc. (MMC) based on its sustainable operating leverage. However, high pension costs, integration expenses and weak global cues continue to impact the highly optimistic outlook in the near term.
Marsh & McLennan reported its second quarter operating earnings of 50 cents per share, a couple higher than the Zacks Consensus Estimate of 48 cents but significantly higher than the loss of 6 cents per share reported in the year-ago quarter.
With the steady recovery in the economic environment, Marsh & McLennan posted improved results on account of top-line growth in all lines of businesses and reduced operating expenses that also drove the operating margin. These were partially offset by investment losses, higher compensation and benefits along with tax expenses.
Marsh & McLennan has a history of outperforming its peers due to its size, diverse product offering, global presence and technical expertise, thereby giving stiff competition to arch-rivals such as Aon Corp. (AON). The company’s broking and consulting divisions of Guy Carpenter, Mercer, Marsh and Oliver Wyman have been modestly contributing to the fundamental growth.
We believe a stable economy and improvement in the insurance cycle should help boost both the insurance brokerage and consulting businesses.
Marsh & McLennan’s steady earnings growth and modest operating cash flow continues to support debt reduction and capital deployment effectively. This has also helped in diminishing the interest expenses and in de-leveraging the balance sheet.
Meanwhile, in August 2011, the company sanctioned a share repurchase program of $500 million, thereby expanding the previous share repurchase program of $500 million, which was granted in September 2010. Even a 10% dividend appreciation in a year’s time has helped boost the shareholders’ confidence.
Moreover, Marsh & McLennan’s unutilized $1.0 billion revolving credit facility along with expected tax benefits in the upcoming quarters shall provide a cushion to the company’s liquidity given that the company’s core operations are not capital intensive.
On the flip side, Marsh & McLennan is encumbered with significant pension obligations toward its employees that mounted to $11 billion at the end of 2010. This is also reflected in higher compensation and benefits costs, including increased pension costs and higher consulting costs, which in turn puts an additional burden on financial leverage while also influencing its credit ratings. Additionally, it could also hamper the company’s investment portfolio and impede the process of raising capital in future.
In relation to the past, generating new business and client retention have also become difficult as clients now choose to spread their businesses among multiple brokers to achieve pricing power and as a hedge against further abuse by a broker, thereby increasing the competition against other brokers as well.
Besides, external factors such as weak property-casualty market amid the soft pricing environment and an increasing tendency for risk retention by the clients have been compounding the stress created by these internal problems. Even the fee-based business has been of little help in attaining the targeted growth.
Increased dependence on the international business further accentuates the risk on account of currency fluctuations, interest and tax rates. Moreover, acquisitions give rise to the risk of integration, primarily amid the volatile global economic scenario.
Given the pros and cons, the Zacks Consensus Estimate for the third quarter is projected at 26 cents per share, a penny lower than the year-ago quarter. For 2011, earnings are projected to be $1.81 per share, about 10% higher over 2010.
Additionally, the quantitative Zacks Rank for Marsh & McLennan is currently #3, indicating no clear directional pressure on the shares over the near term.
