Time to Dump Some of Your Insurance Stocks Says Expert Analyst from Macquarie Group

Wall Street Transcript

67 WALL STREET, New York - August 2, 2012 - The Wall Street Transcript has just published its Insurance Report offering a timely review of the sector to serious investors and industry executives. This special feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Insurance Reserves Adequacy - Low Profitability and Low Interest Rates - Commercial Line Brokers and Underwriters - Life and Property/Casualty Insurers

Companies include: Arthur J Gallagher & Co. (AJG), Marsh & McLennan Companies, In (MMC), Willis Group Holdings Ltd. (WSH), Allied World Assurance Company (AWH), ProAssurance Corporation (PRA) and many others.

In the following excerpt from the Wall Street Transcript Insurance Report, Ray Iardella, an expert analyst, discusses his outlook for the sector and for investors.

TWST: It is your view that the insurance brokers have become increasingly rich. Would you elaborate on your thoughts about the outlook for that segment, and also comment specifically on your two downgrades recently?

Mr. Iardella: We downgraded Aon (AON) and Gallagher (AJG) back in early May, so a little bit over a month ago. And really, the thought process there, I think people were getting very excited about commercial property and casualty insurance pricing, particularly on the property side, and also pretty upbeat on the economy - two of the things that really drive revenues for the insurance brokerage group. So just looking at valuation - they were trading around nine times EV to EBITDA - the thought process was fundamentals don't justify the valuation at that point in time. It's not to say if we get an improving economy globally - including the U.S., and then, commercial P&C pricing continues on the current trajectory - that valuation couldn't move higher. I just think the stocks had moved a little bit ahead of where they should have been. So that's kind of the thought process on the insurance brokerage group overall.

More specifically about Gallagher and Aon: first on Aon, during the first quarter, I think investors and I were positively surprised on the organic growth side of the story for Aon, but more important, the margins just weren't there for me. The company is making a lot of investments both on the insurance brokerage side and the consulting side of the business. I believe the investments are good for the story longer term, but at this point where we are in the insurance cycle and where we are in the economic cycle, I like companies that are going to be able to grow organically and expand margins. And it just didn't seem like the margin expansion story is setting up well for Aon in 2012.

Now, you can argue that margins will improve next year, and you should be in Aon for 2013. At the same time, I think I need to see that these investments are actually paying off in terms of organic growth and margin expansion, and then I can get more constructive on Aon longer term.

And then, for Gallagher, it goes back more to my macro view as I think expectations were a little bit ahead of themselves. Gallagher was trading well above the group average - the nine times EV to EBITDA number that I threw out earlier - and I think organic growth is moving in the right direction, 3% to 4% at this point in time. But I think people are expecting that to continue to move much, much higher. And like I said, I just don't think we are actually there yet in terms of the macro environment for any of the insurance brokers. So that was really the reason for the downgrade of Gallagher, in particular. Plus, Gallagher had been one of the best-performing insurance brokers over the past year at the time of our downgrade, so I think the stock had reacted well to pretty impressive results Gallagher was reporting.

TWST: That all being said about the brokers, you do have "outperform" ratings on a few of them. What sets those companies apart from their peers?

For more from this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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