Earnings Call Transcript
Aon plc (AON)
Earnings Call Transcript - AON Q2 2023
Operator, Operator
Good morning, and thank you for holding, welcome to Aon Plc's Second Quarter 2023 Conference Call. At this time, all parties will be in a listen-only mode until the question-and-answer portion of today's call. I would also like to remind all parties that this call is being recorded. If anyone has any objections, 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 historical results or those anticipated. Information concerning risk factors that could cause such differences are described in the press release covering our second quarter 2023 results as well as having been posted on our website. Now it's my pleasure to turn the call over to Greg Case, CEO of Aon Plc.
Greg Case, CEO
Thanks, Rob, and good morning, everyone. Welcome to our second 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're pleased to report that our global team delivered another strong quarter, performance, results, and momentum. We begin the call today by thanking our colleagues for everything they do to help our clients address immediate and long-term demands around risk and people. United, delivered by our colleagues, gives us the ability to meet this demand and balance across our portfolio, capitalizing on innovation and momentum and investing to meet demand. This ensures we win more, retain more, and do more with our clients. There is now almost universal agreement among clients that demand to address risk and human capital has never been greater. For example, our catastrophe insight report estimated global economic losses for natural disasters in the first half of 2023 to be $194 billion, notably above the 21st-century average of $128 billion, and the fifth highest on record. Even more profound, in addition to economic costs, we know these disasters have tragic human costs that reinforce the high value of building resiliency and protection in advance of disaster. To this end, we recently announced the placement of the Parametric insurance program for the government of Puerto Rico. It's the single largest program of its kind that the U.S. Commonwealth has ever placed. This program was designed by our reinsurance and commercial risk teams. In the event of a sizeable earthquake or hurricane, Puerto Rico will quickly receive liquidity, enabling its government to focus on rapid recovery and reconstruction. This placement was the result of Aon's data, analytics, and capabilities from across our firm, supported by our deep understanding of public entity demand, risk capital, and reinsurance markets, along with the excellent work by our team. Turning to financial performance, in the second quarter, we delivered strong organic revenue growth across our solution lines, including 10% growth in health solutions and 9% growth in reinsurance solutions, contributing to 6% overall organic growth in the quarter and 7% in the first half. In health solutions, revenue growth of 10% on top of 11% last year was driven by strength in the core. Our team has done terrific work helping clients navigate the demands of their talent agendas, balancing optimal benefits for their people with inflationary cost pressures, while also taking steps to deliver on their people strategy at a time when integrating total rewards, health, and wealth benefits is more important than ever. In reinsurance solutions, our team delivered another very strong quarter at 9% organic growth on top of 9% last year. This was driven by strong net new business generation, and our teams continue to help clients navigate a challenging and complex market. We're also seeing capital come into the market, particularly in cat bonds, as our team has placed over $5 billion across 21 deals year-to-date. In wealth solutions, we delivered 2% organic growth driven by ongoing trends in demand we've seen in project work around market volatility and regulatory changes, as well as the ongoing trend of pension derisking, which we expect to continue in the coming quarters, given the current market conditions. Overall, in the quarter, our strong performance was driven by the strength of our Aon United strategy and Aon Business Services platform. In Q2, we translated 6% organic revenue growth into 110 basis points of operating margin expansion. These results contributed to first half financial performance of 7% organic revenue growth and 90 basis points of adjusted operating margin expansion. We're well-positioned to maintain this momentum and deliver on our ongoing financial guidance of mid-single-digit or greater organic revenue growth margin expansion and double-digit free cash flow growth for 2023 and the long term. This financial performance is a result of our ability to address client needs through Aon United. Take human capital; our clients are changing how they're thinking about their colleagues. We're facing an increasingly complex external environment with pressures around cost, growth, remote and hybrid work, and workforce composition. Our connectivity across health, wealth, and talent enables us to bring data, analytics, and solutions to address this need. In summary, our strong performance is directly related to our ability to help clients better understand their challenges and opportunities, taking actions to protect their business and improve their performance. Further, our recently announced enhanced focus on risk capital and human capital is already driving benefits and strengthening this capability. Our strong year-to-date financial results, including 7% organic revenue growth and 90 basis points of margin expansion, position us well to continue delivering in 2023 and over the long term. Now I'd like to turn the call over to Christa for her thoughts on our financial results and long-term outlook for continued shareholder value creation.
Christa Davies, CFO
Thanks so much, Greg, and good morning, everyone. As Greg highlighted, we continued delivering on our key financial metrics, both in the quarter and year-to-date. Through the first half, we translated 7% organic revenue growth into 90 basis points of adjusted operating margin expansion. These results position us well to continue to drive results in 2023 and over the long term, and we look forward to building on this momentum. As I reflect on our performance through the first half of the year, organic revenue growth was 6% in Q2 and 7% year-to-date. We expect mid-single-digit or greater organic revenue growth for the full year 2023 and over the long term. I'd note that reported revenue growth of 7% in Q2 also includes an unfavorable impact from changes in FX of 1% for Q2 and 2% year-to-date, driven primarily by a strong dollar versus most currencies. Moving to operating performance, we delivered strong operational improvement with adjusted operating margins of 33.6% in the first half, an increase of 90 basis points driven by revenue growth and efficiencies from Aon Business Services, overcoming expense growth, including investments in colleagues and technology to drive long-term growth. Looking forward, we expect to deliver sustainable 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 stated previously, Aon Business Services remains one of our key drivers of margin improvement, and this operating model has reached an inflection point. In response to client demand and the opportunity, we're evolving to an organization that drives efficiency, operating leverage, and margin expansion to one that also increasingly delivers improved client service and accelerates innovation at scale. This evolution of Aon Business Services requires investment in three areas, which we expect to manage in line with our ongoing financial guidance and on a disciplined ROIC basis: First, standardized platforms; we're digitizing and connecting existing platforms and creating an ecosystem that encompasses technology and operations that brings our data, analytics, and expertise together for our clients and colleagues. Second, standardized operations; we see an opportunity to bring operations and expertise together across our firm to support clients across all solution lines, enabling us to scale best practices. Third, new products at scale; we see significant opportunity to deliver new data-driven products that we can then effectively develop and scale. The work we've done to standardize platforms and operations empowers us to rapidly develop and deliver innovative solutions across the portfolio. Even more importantly, operating Aon Business Services as one organization with disciplined prioritization and governance around initiatives ensures we can move quickly on opportunities that create value for our clients and colleagues. We translated strong adjusted operating income growth into adjusted EPS growth of 5% in Q2 and 6% year-to-date. As noted in our earnings materials, FX translation had an unfavorable impact of approximately $0.05 in the quarter and $0.19 per share year-to-date. If currency remains stable at today's rates, we would expect no impact in the third quarter and a favorable impact of $0.05 per share in the fourth quarter for an unfavorable impact of $0.14 per share for the full year 2023. We'd also note other nonoperating expenses had a $0.25 per share or 10% unfavorable impact in Q2 and a $0.44 per share or 6% unfavorable impact year-to-date. This reflects an unfavorable impact from an increase in noncash net periodic pension expense, along with a gain on the sale of businesses in the prior year period and balance sheet FX remeasurement in the current period. Moving to free cash flow and capital allocation, cash from operations was flat year-over-year, and free cash flow decreased 7% to $986 million, primarily driven by a $77 million increase in CapEx. Free cash flow can be lumpy quarter to quarter, but we expect free cash flow generation in the second half of the year to be seasonally stronger than in the first half. We continue to expect double-digit free cash flow growth for the full year. CapEx has elevated in the first half of the year compared to the prior year period as we've initiated a number of projects with spending heavily weighted in the first half across technology to drive long-term growth. We now expect an investment of $220 million to $250 million in CapEx in 2023, but we manage it like all of our investments on a disciplined ROIC basis. Our outlook for free cash flow growth 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 improvement. Given our strong outlook for free cash flow growth in 2023 and beyond, we expect share repurchase to continue to remain our highest-return-on-capital opportunity for capital allocation. We believe we're significantly undervalued in the market today, highlighted by approximately $1.1 billion of share repurchase year-to-date. We also expect to continue to invest organically and inorganically in content and capability that we can scale to address unmet client needs. Our M&A pipeline continues to focus on our highest-priority areas that will bring scalable solutions to our clients' growing and evolving challenges. We will actively manage the portfolio and assess all capital allocation decisions on an ROIC basis. 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 grows over the long term while maintaining a strong investment-grade credit profile. I'd note our term debt is all fixed-rate with an average weighted interest rate of approximately 4% and an average weighted maturity of approximately 11 years. In summary, our strong financial results for the quarter and year-to-date reflect strong operational performance driven by our Aon United strategy and Aon Business Services platform. We expect to continue to make progress on our key financial metrics and our commitment to drive long-term shareholder value creation.
Operator, Operator
And our first question comes from Charlie Lederer with Citi.
Charlie Lederer, Analyst
You mentioned continued headwinds in M&A services in the back half of this year in your prepared remarks. When should we think about that dynamic lapping? And is it more of a pricing issue? Or can you comment on what's driving that?
Greg Case, CEO
I really appreciate the question, Charlie. Start overall with commercial fundamentals generally. Obviously, that's part of the real question. Very strong retention, very strong new business, exceptional strength around geographies, particularly in core P&C. It really is just this one area in M&A services which is a particular strength of ours. But as you know, deal count and volume are down 30% to 40%. We expect that in the first half of the year, we expect to see it in the second half. As that comes back, we will respond positively just given our overall position. But Eric, anything else you'd add to that?
Eric Andersen, President
Yes, Greg, I would just say that while the deal volume is down, we have been spending time with the team expanding the potential client base. The historic nature of the product has been more driven towards private equity-type buyers. But we've been working with corporate clients to ensure they're aware of the capabilities and how those products and services get utilized. So when the market does come back, and it will come back, we'll be positioned to lead that market as we do today.
Christa Davies, CFO
And Charlie, I would just say that while we've lapped the downturn, we do expect the pressure to continue in the second half as the external outlook has continued to be soft.
Charlie Lederer, Analyst
And then I'm wondering if you can comment on the momentum in your IP business, intellectual property. How meaningful is that to organic revenue growth? And there have been some articles in the press about it recently. So just trying to understand how you see that business affecting second half results, if at all?
Greg Case, CEO
Love this question, Charlie. Really appreciate you raising it. We love this business. It is a phenomenal opportunity for us. If you think about intellectual property overall, this is just hugely significant. We talked before about 85% of the value of the S&P 500, which really ties back to intangible assets. Since 2016, we started with an amazing investment, bringing in 601West to Aon; it's about 20 to 25 colleagues. We've now invested in hundreds of colleagues with a truly unique market-leading platform to help understand these opportunities and the risks associated with these assets. We've built a marketplace with many insurers—26, almost 30 insurers in the marketplace—with $2 billion in aggregate insured transaction value. Demand is stronger than ever, and we're evolving in the market, with numerous third parties affecting that. We love our position, the progress we've made, and we feel stronger than ever about the future opportunity.
Eric Andersen, President
Yes, maybe two things, Greg. One, as a percentage of revenue, the market is still in its early stages, so I wouldn’t emphasize it too heavily other than the potential we foresee in the future. Regarding your second question about the market activity, we will not comment on specific third parties, but as part of our essential role in matching risk to capital, we collaborate with many entities that provide capital to the marketplace. Some of these entities utilize us as a credit to support the capital used by the third parties, but it offers the kind of capital our clients require to secure the reinsurance capital they are seeking. This is just one of the ways we align risk with capital for our clients.
Operator, Operator
Our next question is from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question.
Mike Zaremski, Analyst
Back to the organic growth environment. Just curious, you mentioned some headwinds on the M&A side. There's probably some tailwinds too, which we can see. Would you say growth is either steady, accelerating, or decelerating? Or are there any trends you'd like to point out in your businesses in terms of momentum or tailwinds other than the M&A call out that we should consider into the back half of the year?
Greg Case, CEO
Yes. Mike, I love this question. If you think about sort of the growth platform and how it's evolved first, just for context, we think about growth and really all the benchmark objectives over the course of the year. For us, growth is organic revenue and growth is margin improvement, and growth is absolutely the translation into free cash flow. We see momentum around meeting our full-year 2023 objectives. This is mid-single digit or greater across the board, looking at strengths in health, which were exceptional for the first half, and certainly for the quarter in reinsurance and other areas too, even in commercial risk with the headwind we just highlighted. Very strong on the solution line side. You saw exceptional movement on margin expansion. When you think about the growth here to 110 basis points for the quarter and 90 basis points for the first half. Most importantly, you heard Christa reemphasize double-digit free cash flow growth for the year. We see this trend continuing.
Eric Andersen, President
Sure, Greg. You mentioned two examples in your remarks around the Parametric for Puerto Rico and the Human Sustainability Index. Those are just two examples of the Aon United teams working together. The client demand is evolving, and it's getting more complicated as the world gets more complex. Our strategy of evolving to risk capital and human capital uniquely positions us to utilize that capital to drive growth. It gives us access to global capital no matter the form: insurance, reinsurance, ILS, parametrics. It helps clients transfer the risk they want to transfer and creates more dynamic markets. It also helps us deliver the analytics that have historically driven our reinsurance business over to the large corporate clients, who have a more acute need today.
Christa Davies, CFO
Mike, you also asked about the second-half outlook. Year-to-date growth was 7%. We do think about our results across the full year. We are on track for our full-year guidance of mid-single-digit or greater organic revenue growth, margin expansion, and double-digit free cash flow growth. We’re excited about the momentum in the first half continuing into the second half. We consider different seasonality in revenue but think about it across the full year.
Mike Zaremski, Analyst
My quick follow-up is on the expense efficiency side. Several competitors have discussed finding more ways to be efficient in this post-pandemic world. Does your strategy indicate that you see incrementally more opportunities for expense efficiencies or nothing substantially different?
Christa Davies, CFO
Look, we do see opportunities for expense efficiencies. We are on the next evolution of Aon Business Services. We're expanding from just driving efficiency to really improve customer service delivery, innovation at scale, which helps accelerate growth. We've seen 90 basis points of margin expansion year-to-date and offset it by investments in technology and colleagues. We've made significant investments in IT, up 13% year-to-date, primarily around our core business platforms to support revenue growth.
Eric Andersen, President
One comment on efficiency; while there is a focus on efficiency, we also see great opportunities to drive new products and better solutions for our larger clients. For example, utilizing the analytics we have to help clients manage their climate exposure is part of the Aon Business Services strategy and execution. Yes, we recognize the efficiency side, but we also see great opportunities for growth.
Greg Case, CEO
To remind you, Mike, we've been working on this since 2017. With the leadership under Christa, we've built a tremendous amount of capability. Now we're moving on to the next wave, building on that strong foundation. We’re excited about both the efficiency and effectiveness outcomes that Aon Business Services brings us.
Operator, Operator
Our next question comes from the line of Weston Bloomer with UBS. Please proceed with your question.
Weston Bloomer, Analyst
My first question is on compensation and benefits; it looks like that picked up meaningfully over the last five quarters, and you've highlighted investments in colleagues. Can you comment on the pace of hiring you’re seeing broader? Was there perhaps a pickup in retention-based comp in the quarter? I'd be curious about attrition rates in commercial risk and reinsurance as well.
Christa Davies, CFO
If you think about this, from an overall year-to-date perspective, organic revenue growth is 7%. Comp and benefits are up 4% year-to-date. There’s lumpiness in every quarter, but we feel good about where we are. Attrition in 2023 is below 2019 levels, or below pre-pandemic levels. We feel good about engagement levels, now at the highest in the firm's history.
Eric Andersen, President
The industry often reads too much into headlines about talent movement. We are making significant investments in talent in our core health and benefits business and areas where we see growth opportunities. Our platforms allow us to increase how we deploy talent flexibly. We're investing heavily in our talent and expect to continue to do so.
Weston Bloomer, Analyst
My second question is on wealth solutions organic growth. I wonder if you could quantify the impact of performance fees in the quarter, and do you see mid-single-digit organic growth over the next year?
Eric Andersen, President
The wealth solutions business is a great business for us, and we do see growth opportunities over the mid to long term. The retirement piece, pension actuarial work, continues to be solid, with activity driven by pension derisking and regulatory changes. The advisory business continues to be strong. Overall, we are bullish on the business and expect it to reach mid-single digits moving forward.
Operator, Operator
Our next question comes from the line of Bob Huang with Morgan Stanley. Please proceed with your question.
Bob Huang, Analyst
I know that you talked about tech innovation and efficiency. Maybe if I can dig deeper on the cost of AI implementation. Microsoft announced that their AI-enabled products are twice as expensive as non-AI-enabled products. Can you help us think about the cost of your AI investments fitting into your areas of investing with the Aon business right now?
Christa Davies, CFO
Thank you for the question, Bob. We're excited about AI in how it can apply to our business. We think about it from basic machine learning and robotic process automation, which drive automation and efficiency at a low cost, to generative AI, which helps drive insights and impact in analytical areas. We're managing costs by implementing technology appropriately depending on the impact and opportunity.
Greg Case, CEO
We've been incorporating AI for over a decade. One of the reasons we drove Aon Business Services forward was to enable this scaling. Aon Business Services allows us to scale these ideas effectively worldwide.
Bob Huang, Analyst
My second question is about Commercial Risk Solutions, specifically Asia and Latin America. How durable is the growth there? How should we think about Commercial Risk Solutions growth moving forward?
Greg Case, CEO
We feel very good about the overall trajectory, as you've highlighted. Our fundamentals are strong, and the capabilities we've built in the M&A services area will pay off as the market rebounds. We’re also seeing great demand in Asia and Latin America as those economies develop.
Eric Andersen, President
The sophistication of products entering Asia-Pacific and Latin America continues to evolve. As the economies develop, we grow with them, and there are good long-term growth opportunities.
Greg Case, CEO
I was recently in Singapore, opening our global climate hub and was encouraged by seeing various clients whose needs are evolving to require more global solutions. They want to see global Aon reflected in their local areas. There's a very positive outlook for our future opportunities.
Operator, Operator
Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question.
Rob Cox, Analyst
In reinsurance solutions, really strong results, but would you expect to see more sequential acceleration given the exposure to property cat in the U.S.? Can you provide color there?
Eric Andersen, President
We are proud of our reinsurance capabilities. The first half has been great. Most treaty business happens in the first half, so expectations around client decisions may have affected growth. The primary market dynamics also factor in as clients navigate their reinsurance capital usage.
Rob Cox, Analyst
If we exclude external factors in the M&A services business, is it fair to assume that the remainder of the business accelerated sequentially along with renewal premium changes?
Christa Davies, CFO
We are excited about a year-to-date growth of 7% overall for Aon. There has been a real headwind in the M&A area, given that transaction volume has dropped, as Greg described. We expect that softness to persist in the second half.
Rob Cox, Analyst
Regarding the health solutions, growth outside the U.S. seems significant. What is driving this? Is it market share gains or medical inflation?
Eric Andersen, President
The strong growth outside the U.S. is largely due to market share gains and our ability to help global clients navigate the complexities of various health systems around the world. We believe this reflects our global team's strong connections.
Operator, Operator
Our next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question.
Elyse Greenspan, Analyst
Christa, I wanted to confirm if the CapEx guidance is still around $200 million to $225 million for the year. With improvement in free cash flow in the back half of the year, will that come from a combination of lower CapEx and growth in operating cash flow?
Christa Davies, CFO
Elyse, we have increased our CapEx guidance to $220 million to $250 million for 2023, driven by investments across Aon Business Services platforms and applications. The improvement in free cash flow will come from operating income growth and working capital, as the second half typically shows stronger cash flow generation.
Elyse Greenspan, Analyst
With the easier comps in the back half, do you expect sequentially better growth considering the continued headwinds in M&A volume?
Christa Davies, CFO
Elyse, we are lapping easier comps, and while there will be some pressure into the M&A environment in the second half, we expect overall trends to continue positively.
Elyse Greenspan, Analyst
In reinsurance solutions, I’m curious about your perspective on capital opportunities for the rest of the year and prospects for 2024.
Greg Case, CEO
Overall, there continues to be pressure on the capital side. We’re vigilant about finding options and navigating through them. We’ve seen a movement on the ILS side, indicating opportunities, having completed $5 billion across 21 deals year-to-date. There is still pressure, but we have substantial capabilities.
Eric Andersen, President
We’re seeing investors allocate more to cat bonds, with some returning to the market, creating expanded opportunity. We believe we are reaching an equilibrium in pricing within the reinsurance market.
Operator, Operator
The next questions are from the line of David Motemaden with Evercore ISI. Please proceed with your question.
David Motemaden, Analyst
Can you size how much of a drag capital markets activity had on organic growth in commercial risk this quarter?
Christa Davies, CFO
We haven’t disclosed that detail, but we're incredibly excited about our capabilities, especially in the face of the headwinds, as we continue to invest. Our position in the commercial risk market remains strong.
David Motemaden, Analyst
Are you expecting a recovery from last year's depressed levels given that the comps are easier?
Greg Case, CEO
Yes, as transactions come back, we are well-positioned with the broader commercial applications. Our strength in core areas will support our recovery. We are building stronger ties overall with clients through our strategies.
David Motemaden, Analyst
I noticed that your continued investment in tech and talent seems to be transitioning from CapEx to OpEx more in the back half, which could present a headwind to margin improvement. Is that correct?
Christa Davies, CFO
We see this year’s investments as a full-year positive regarding CapEx estimates while balancing margin expansions. We expect margin expansion sustainability through the year with careful management of our investments.
Operator, Operator
The next question is from the line of Meyer Shields with KBW. Please proceed with your question.
Meyer Shields, Analyst
Can you give guidance on the margin impact from the M&A practice, either what you've seen in recent quarters or what that implies for margin expansion when this business line recovers?
Christa Davies, CFO
We're focused on continuing to invest in our portfolio efficiently. Operations are being adapted to create value for clients while ensuring margin sustainability in the long term.
Meyer Shields, Analyst
What is your outlook on tax rates considering OECD minimum tax reform?
Christa Davies, CFO
We are not providing guidance on the tax rate but have maintained a historic underlying rate of approximately 18%. We're confident in our global capital structure and our ability to navigate regulatory changes.
Operator, Operator
Our last question is from the line of Jimmy Bhullar with JPMorgan. Please proceed with your question.
Jimmy Bhullar, Analyst
How do you assess inflation's overall impact on your business? Is it positive overall with revenue growth versus potential talent comp and technology expense increases?
Christa Davies, CFO
Inflation overall is good for our business. We've observed inflation impacts on the revenue side. We expect that impact to contribute positively to our revenue, particularly in commercial risk and health insurance prices.
Eric Andersen, President
Inflation affects clients' decision-making, impacting how they manage risks. They may opt for higher retentions or utilize captives, leading to new opportunities for us in providing solutions.
Jimmy Bhullar, Analyst
Regarding share buybacks, historically, they were higher in the second half. Should we expect a similar trend this year?
Christa Davies, CFO
We focus on cash allocation based on return on capital. Share repurchases remain our highest-return-on-capital initiative. We have opportunities for investment in buybacks based on our evaluations of cash generation.
Greg Case, CEO
Thank you, everyone, for joining, and we look forward to the discussion next quarter. Have a great day.
Operator, Operator
This will conclude today's conference. Thank you for your participation. You may now disconnect your lines at this time.