Aon Stock: Q2 2024, New Business Net Growth, Strong Retention (NYSE:AON)

I published my Strong Buy thesis on Aon (NYSE:AON) in February 2024, indicating that the NFP acquisition could potentially accelerate Aon’s organic revenue growth and expand its business into the middle market. The company released its second-quarter results July 26^t with 6% organic revenue growth. I am a believer in the company’s growth driven by net new business generation and ongoing strong retention. I maintain a Strong Buy rating with a fair value of $410 per share.

Net new business growth and strong retention

In the second quarter, the company reported 6% growth in organic revenue and adjusted earnings per share, as shown in the chart below.

My biggest takeaway from the quarter is Aon’s growth, driven by net new business generation and continued strong retention. Strong retention spans all of Aon’s major business segments, including Commercial Risk, Reinsurance Solutions, Health Solutions and Wealth solutions. I think strong new business acquisitions and high retention will continue in the future for the following reasons:

• Aon has strategically shifted its business into high-growth areas such as cybersecurity, risk management, human resources, and retirement markets. These sectors offer greater growth potential than Aon’s traditional insurance brokerage business.
• As announced on its earnings conference call, Aon leverages its venture capital and human capital structure to secure large transactions from corporate clients. The integrated corporate structure enables Aon to provide comprehensive services to corporate clients.

Completion of NFP and expansion into the medium-sized enterprise market

On April 25, Aon announced the completion of its acquisition of NFP for an enterprise value of $13 billion. As detailed in the slide below, NFP enables Aon to expand its services into the fast-growing middle market, providing its clients with a risk, health and wealth broker.

As discussed in my previous article, I think the deal makes strategic sense for Aon, and NFP has the potential to accelerate Aon’s organic revenue growth going forward. Key reasons include:

• Aon anticipates generating $300 million of cost synergies in fiscal 2025 and $600 million in fiscal 2026. Additionally, management is confident that Aon will realize revenue synergies with NFP as the combined services have the potential to help both companies continue to expand their large customer bases.
• Compared to large enterprises, the mid-market is fragmented, with many small players competing with each other. Under the Aon umbrella, NFP could strengthen its brand image in the mid-market. NFP could also leverage Aon’s solid platform and technology to digitize operations and increase efficiency.

Outlook and valuation

Aon forecasts organic revenue growth in the mid-single digits for fiscal 2024, as detailed on the slide below.

I take into account the following factors influencing growth in the short term:

• As indicated in the earnings call, NFP delivered organic revenue growth to MSD in Q2. Upon full integration, I believe NFP could potentially deliver higher revenue growth through revenue synergies.
• I predict Aon will be able to generate 4% revenue growth from existing customers, driven by 2% price increases and 2% service expansion.
• Additionally, I forecast that Aon could generate 2% net new customer growth, which is in line with the historical average.
• Finally, I expect NFP to contribute 7% to revenue growth in FY24. From FY25, I assume Aon will allocate 5% of total revenue to acquisitions, contributing 2.5% to revenue growth.

As a result, I forecast Aon to achieve 13% total revenue growth in fiscal 2024 and 8.5% from fiscal 2025.

While corporate restructuring and cost synergies could help Aon improve its operating margin, its reported operating margin is likely to decline in the coming years due to integration costs and higher depreciation costs related to the NFP agreement. I calculate Aon’s operating margin to decline to 17.3% in FY26 and then recover to 26.3% by FY33. It is worth noting that Aon had a 28.3% operating margin in FY23. Therefore, my margin assumptions are quite conservative.

The DCF summary looks like this:

The weighted average cost of Treasury bonds (WACC) was calculated at 8.5%, assuming: a risk-free rate of 4.2% ((10-year US Treasury yield)); beta of 0.65 (SA); equity risk premium of 7%; cost of debt of 7%; equity balance of $70 billion; debt of $11 billion; tax rate of 19%.

After deducting all future FCF, the fair value is estimated at $410 per share. The current share price is just 20x FCF, which is a fairly cheap multiple for a company with double-digit earnings growth.

Key risks

Any large acquisition could potentially involve a number of integration risks, including legal, compliance, human resources and sales force. It is uncertain whether Aon can successfully integrate NFP’s operations, particularly with respect to senior management and the sales team.

In addition, insurance premium growth has been a key driver for Aon over the past few years, as Aon generates some income from insurance commissions. The strong growth in insurance premiums has been driven by high inflation; however, with inflation declining, it is uncertain whether insurance premiums will continue to grow significantly in the coming years.

Final Note

I am a big believer in Aon’s organic revenue growth and its businesses in high-growth areas such as cybersecurity, health, retirement, etc. NFP enables the company to expand its services into the middle market, potentially accelerating organic revenue growth. Since the stock is undervalued, according to my DCF model, I reiterate a Strong Buy rating with a fair value of $410 per share.