The company has a proven historical track record of continued revenue growth – both organic and inorganic. The company has an experienced team of leaders, a diversified revenue base, and a capital allocation strategy that while not focusing on shareholder returns through dividends, has nonetheless rewarded shareholders with significant returns.
From its $3B of revenue, the company manages to squeeze a 30-33% EBITDAC margin – and that 30%+ is something the company has managed for over 4 years.
In a way, this operating model is far safer than an underwriting-exposed insurance shop in the more traditional sense. The company simply takes a small cut in the form of commissions, paid both from insurance companies, and in some cases from its customers for certain services as well.
The revenue commissions are typically a portion of the premium paid by the insured and highly depend on the sort of insurance that BRO has helped sell, whom for, and the relationship of the client company with BRO. In some cases, BRO also has profit-sharing contingent commission agreements with some of its clients – but in essence, it can be said that the company makes money through small cuts on the services and products that it sells.
You can see the segment and operational divisions above. BRO runs a very decentralized sales & service model – it centralizes certain corporate functions, but allows its sales and services to remain spread out.
Here is the company’s history from a small, sub-$250M shop to a $3B-insurance brokerage/agent operation.
The company has integrated over 575 acquisitions into its operations – so to call them a “proven” operator is even a bit of an understatement here. Back in 1993, the company’s total annual revenues were around $94M. Today, it’s over $3B – and in time it’s diversified its business mix into incorporating more national programs, and more wholesale brokerage operations.
Generating near-on 600% TSR for 10 years makes this company better than most investments during the same timeframe. The company has also averaged 12% revenue growth for the last 10 years, every year.
The company uses debt to enhance its returns and typically carries a net debt/EBITDAC of between 0.5x to 1.5x not any worrying degree at all. The company doesn’t have any significant maturities until 2024 at the earliest.
Furthermore, Brown & Brown is well-positioned to go into the future and deliver similar levels of profits as we move forward. Future drivers of outperformance are exactly what the company has been doing for the past 40 or so years. Industry consolidation and geographical expansion, apart from its efficiencies and other levers.
The insurance market is likely to see continued changes in terms of pricing, inflation, and other trends. The company is in fact one of the largest in the US in what it does – found behind other companies I review in much the same segments, such as Marsh & McLennan (MMC) and Aon plc (AON), both of which I’ve written about before, as well as a few others. BRO isn’t that far ahead of number 6 or the ones behind, but it’s a very efficient operation.
The argument for a company like Brown & Brown is that insurance carriers themselves typically don’t have a large or expertise-heavy distribution organization. Also, the customers which want insurance, such as individuals, businesses, or organizations, don’t have the expertise, inclination, or interest to actually do the research or shop around for what they need or want in terms of their insurance needs.
So, meet Brown & Brown – and similar, aforementioned businesses and their reasons for making money. They add value to insurance operations by providing expertise, and customizing products, and can even help expedite claims. They can also use scale to negotiate pricing for plans – again, the customer side of the operation.
Recent results confirm the attractiveness of these trends. Most of the company’s sectors reported positive results, meaning growth on an organic basis, and while results showed impacts due to recent hurricanes, the overall picture is generally fairly positive. The company completed further M&As, growing its portfolio of businesses which are already performing very well. Despite Hurricane impacts, the company saw 31.2% EBITDAC margins on an adjusted overall basis, with a net income of over half a dollar per share.
Ian is expected to bring upwards of 11,000-12,000 claims, driving around $11-$14M worth of revenues – it’s important to remember that BRO has a bit more exposure here given its flood insurance lines.
Further on the positive side, trends in infrastructure businesses and healthcare continue to be positive despite the downward adjustment of GDP. The company is also seeing that small business owners, as well as medium-business owners, are starting to become more cautious with regard to spending and hiring as their outlook in terms of growth estimates is starting to moderate.
However, much of the market for BRO is still as much as it’s been for the past quarters. For the remainder of the year, the company expects the EBITDAC margin to be between slightly negative to slightly positive depending on trends in the last 3 months, but any way this is sliced, it’s still a strong performance given the variety of variable cost increases, hurricane impacts and the current geopolitical macro that we’re facing – and that the company is facing.
If you look at the company from a historical perspective, you’ll find very few periods during which BRO actually performed negatively during a consistent number of years, with the one exception of 08-09. Aside from this, a few negative years, but they’re outliers to the company’s overall 20-year EPS growth average of nearly 12% per year, close to revenue growth rates.
This means that at the right price, this company is nothing short of a “BUY” – despite sporting only a BBB- in terms of credit and despite the somewhat lackluster yield.Brown & Brown – Valuation
BRO should be invested in as a story of industry-leading margins, which is what the company despite its size does offer. The problem is that such quality typically comes at a high price, which has been the company’s story in valuation for going on at least 3-5 years at this point.
The premium to this company is massive – and its 10-year rate is to me, unjustified when we look at what yield, what safety in terms of credit rating, and what sort of upside in the long-term we can get from the investment. At 20-25x P/E or above, I would not be investing in the company – and certainly not at 26x, which is what we have here.
At those prices and under those circumstances, I would rather put my money to work in more broad-based insurance plays, even with the risk of underwriting, but with a more appealing yield and a valuation in the single digits to a P/E multiple.
I’m not opposed to premiums – as you can see in some of my earlier articles on some investments which trade at close to 30x. I’ve even positively talked about investments like Canada Goose (GOOS), but I do want a bit more bang for my buck at those multiples.
Here, that’s not something that I feel I’m getting.
10% EPS growth conservatively is something I can get elsewhere, and with a better yield. The current upside for the company based on historical premiums looks something like this.
Yes, the upside is technically market-beating – but I don’t view the valuation as valid given the excessive premium that’s being applied here. The company can, if we look at the history, at times spend over 5 years trading at multiples well below 20x, and that’s when we want to pick it up to ensure those triple-digit returns we may be looking for from a stock like this.
Until that’s something I can get, I’m not going to be that interested in a sub-1% yielding, BBB- rated insurance broker/agent even with the sublime qualities that BRO has.
Analysts take a somewhat different – yet complex approach to the business. While the 9 S&P Global analysts that follow the company give BRO an average rating of $65/share, implying a more than double-digit upside here, only 2 out of 9 analysts have the company at a “BUY” rating.
This is despite not a single analyst believing the company to be worth less than $60/share, which is above the currently traded share price.
So, the analyst targets are somewhat disingenuous when looking at what recommendations result in from them – but not something we have not seen before.
However, based on industry pressures and company overvaluation coupled with some fundamental issues of yield and credit rating, I would give this company a PT of around $45/share at this point.
At that valuation, given the forward estimates, I would become interested in buying Brown & Brown.
Here is my thesis on the company.ThesisBrown & Brown is a class-leading insurance agency/brokerage with a twist of underwriting going into flood insurance. The company has a solid historical trend of growing earnings, dividends, and rewarding shareholders with above-market returns, but it does come with a sub-par IG credit rating, and a yield that’s under 1%.I view the company as a “BUY” only if you could pick it up at a relatively cheap price – well below where it currently trades.My current PT for Brown & Brown is $45/share. I’m at a “HOLD” here.Remember, I’m all about:Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).This company is overall qualitative.This company is fundamentally safe/conservative & well-run.This company pays a well-covered dividend.This company is currently cheap.This company has a realistic upside based on earnings growth or multiple expansion/reversion.
The company only fulfills 3 out of 5 of my criteria, and is therefore not a valid “BUY” at current time. BRO is a “HOLD”.