Q3 2019 Earnings Call
Okay to organic let me start with the brokerage segment third quarter organic was 5.8% all in which is similar to our organic performance through the first six months of 2019 I'm very pleased that all of our divisions globally contributed to this result for example, our domestic retail.
PC operations had another strong quarter with organic of about 5% our wholesale operations had an excellent quarter posting about 6.5% organic this includes over 10% in our domestic open brokerage operations. Our benefits operations also had a strong showing this quarter posting base organic of.
4.5% and then internationally, our retail brokerage operations combined to post 7% organic with Canada up more than 10%, Australia, and New Zealand up about 6% and the UK up 5% another really strong quarter of production by the team.
Let me move to the rate environment.
Moving to the UK UK retail pricing is up over 3% to touch higher than the second quarter in our UK a wholesale operations pricing is approaching double digits across many lines in Canada pricing is up around 8% with property increases more than 10% and finally in Australia, New Zealand pricing.
Moving to exposures in early October we surveyed our producers specifically asking questions related to their clients payroll and exposure units over 75% said their customers payrolls and exposure units grew during the third quarter and more than 95% of these respondents so.
There were seeing similar or stronger client exposure growth as they begin working on 2020 renewals. This is consistent with the results from our May 2019 benefits benchmarking survey, where more than 70% of the 3900 employers believe that their revenue would be increasing over the next two years.
So when I look around the world PC rates and exposures continue to higher distant environment in which our talented production staff excels by delivering the best insurance risk management and benefits consulting advice by leveraging our vast array of resources and capabilities as I sit here today I see our fourth quarter organic.
Nicely in the bid 5% range.
Next let me talk about our brokerage merger and acquisition growth in the quarter. We completed 11 tuck in brokerage acquisitions with estimated annualized revenue of $70 million I would like to thank all of our new partners for joining us and extend a very warm welcome to our growing family of professionals the brokerage team.
He has had a very busy M&A year, completing 35 mergers with more than $330 million of annualized revenues. During the first nine months, adding to that we have already announced a number of mergers in October that should add an additional $90 million of annualized revenue. This is on top of our M&A pipeline Rick.
Toward that shows $400 million of revenue associated with about 50 term sheets either agreed upon are being prepared.
While not all of these transactions in the pipeline will ultimately close as I look around the world, It's clear that our tuck in merger opportunities remain very robust.
Next I would like to move to our risk management segment.
Third quarter organic growth was 5.7% with similar results in both our us and international operations. The growth. We are experienced in is also broad based by client type, including large commercial public sector alternative markets and insurance carrier clients, our investments and innovative products.
Like the award winning mobile App GB go combined with our expertise by product and industry continue to set Gallagher Bassett apart from the competition looking forward, we see mid single digit organic growth in the fourth quarter in terms of mergers and acquisitions, we completed three risk management acquisitions this quarter, adding in.
Annualized revenue of about $15 million these acquisitions provide us with incremental capabilities and services that will benefit our clients in Australia, UK Europe , and the us I'd like to extend a very warm welcome to our new Gallagher Bassett professionals.
Lastly, I'd like to touch on a true competitive advantage. That's Gallagher is unique culture. It has a culture that helps us attract and retain the very best talent a culture that promotes our relationships with our carrier partners a culture that distinguishes us from others in a highly competitive merger environment and it is the basis for our people coming together.
Other as a team to service clients focused on doing the right thing.
Now days, we're hearing a lot about company culture and purpose. This is nothing new to Gallagher, we've long valued all of our stakeholders as defined in our mission statement. Ultimately we believe if we provide value to our clients take care of our employees and build strong relationships with our insurance carrier partners our shareholder.
This will be rewarded bottom line, our culture always has been and we'll continue to be a true competitive advantage.
Okay, great quarter, and first nine months I'll stop now I'll turn it over to Doug Doug.
Thanks, Pat and good afternoon, everyone I'd like to start by thanking the team for another outstanding quarter. It really got position us very well to close out an outstanding 2019 here in the fourth quarter.
Today I'll make a few comments from the earnings release.
I'll walk you then through that CFO commentary document, we post on our website and I'll conclude our with some comments on cash and M&A.
Okay, Let's go to the bottom of page five of the earnings release, the brokerage segment margins.
The quarter, we delivered 68 basis points of adjusted margin expansion that terrific resolve that 5.8% organic growth and thats marks that 32nd straight quarter, our brokerage segment margin expansion I truly amazing Ron and an excellent illustration, how we're constantly focusing on raising.
Our quality and productivity.
Forward, we would expect to see about 50 basis points of margin expansion if organic growth is in the low to mid 5% range.
Let's flip to page second the earnings related to the risk management segment margins.
During the quarter, we put an 18 point of adjusted EBITDAC margin, that's really great work by the team, but well above the upper end of our target. So we wouldn't expect to see that in the fourth quarter, perhaps more like 17 to 17, a half percent, which would finish operating year nicely towards the higher end of our full year target also in that.
17% to 17.5% range.
Let's now move CFO commentary document that we that we can find at our website.
Let's turn to page sale.
Relative to third quarter estimates that we provided during our September IR day, nearly all of the line came in very close a few other comments first our integration efforts, mostly related to the aerospace and stackhouse mergers. We did this summer our old are moving along as planned and on but.
Second.
We're making nice progress on our back office support layer transformation project, we discussed at our IR day, we've already contract and a few hundred position and we Havent nice line of sight into areas, where we can lower our cost and improve our service quality by centralization standardization and automation.
Most of our back office functions, while redeploying these savings into processes to help us drive our organic growth sales support and sales management systems and tools data and sale of analytics additional production down marketing and branding in other words, all our effort that will help a sophomore hire more and acquire more.
And finally still on page.
Modeling out please make sure your models are picking up our estimates for changes in estimated earn outs and also our earnings from non controlling interest neither our big number is that still can move your estimates by a penny or two.
Well stay in the CFO commentary document, but flip to page three corporate site.
Relative to the estimates we provided during our September IR day.
Interesting corporate expense line for both within the range acquisition expense with just a touch higher mostly due to a couple of smaller international deals and then finally to clean energy.
The third quarter adjusted results came in a couple million dollars above the midpoint of the range a great quarter looking forward fourth quarter is looking a bit lower than what we are seeing during our IR day.
Whether thus far in October is not nearly as hot as last year. So we so we moderated our fourth quarter outlook just the that that's added stacking up to be another 100 million dollar year for this investment strategy.
You'll also see a clean energy adjustment line this quarter it clean energy had a very busy quarter.
Putting out to describes four items, we are really we resolved a five year patents fall when a great outcome. We prevailed in tax court, we opened new patent defense litigation, which we think as without merit, but we intend on defending it vigorously and finally, we are making terrific progress and moving three of our 2011 era low.
Our production machine into a really great 2009 era locations.
You can feed us clearly on page four of the CFO commentary in the fourth row on that page.
So the machines are currently producing less than a million dollars of earnings here in 2019, but by moving them, we can achieve $10 million to $15 million of earnings.
Hats off to those engineers and operators and we used to make this habit ROI great job. It's also affirmation from our utility partners that we truly have an excellent process and that we are delivering substantial environmental benefits.
Let's say on that page four you'll see that we are also providing numbers around what we think as possible for clean energy earnings in 2020, that's the far right columns. These are these numbers are still in line with what we said as a very early monk during our September IR day.
You'll see that vitamin moving these machines, we can counteract that natural trend and power production towards renewable thing natural gas.
It's an early look a lot can change, but here, we are a decade ladder and still looking at investment strategy that can deliver great returns for a couple of more years.
At the end of the quarter, we have over $950 million of credit Carryovers on our balance sheet and at least another two years of production ahead of us. So we're well positioned to harvest as hard to earn cash flows well into the mid to late 2020.
Finally, let's move to cash in M&A at September 30, we had about $300 million available cash on our balance sheet death, plus our free cash flow through the year end through the end of the year and our borrowing capacity should round out a year, where we can still invest deeply in our business pay a great dividend and still fund about 1.5 billion.
$1 of M&A before using any stock.
When I look at our pipeline through year end, I think will be close to that level and if we happen to go over it would only mean using a very small amount of stock. This clearly demonstrates the strength of our growing cash flows.
When I look out towards 2020, now looks like we can easily do another $1.5 billion of M&A without using any stock.
So those are my comments, an excellent quarter and excellent nine months back to you pass.
Thank you Doug Devon, we're ready for questions. If so we have some would you open it up.
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One piece will be Paul.
Our first question.
Mike So muskie.
Credit Suisse. Please proceed with your question.
Hey, good afternoon.
After the Mike.
First question so.
As as you guys know.
Better than I do the laws commentary about.
The PNC commercial market hardening and.
Now there are certain.
Views out there that.
Great. So we'll continue to harden.
I know.
Pat you've said that 5% snow hard markets.
And you you said you've got all the best doesn't want to see what what a real hard market looks like since since it's been awhile.
Yes, just if we had you hypothesize that rates just continue to move North maybe you can kind of help us understand what what a hard market would mean in terms.
Hey, guys like ours.
No impact on your financials, and and the pluses and minuses.
Mike Yes sure. Thanks for the question first of all.
Do you hit it right on exactly my line. This is not hard market, it's getting firmer. There's no question about it that when you get into some higher in property stuff catastrophe exposed or places where they've been losses. Our people are working very hard to place those.
Some of the stuff is getting done at the last minute takes more effort more more submissions to more SNS markets to get it completed we're seeing excess casualty.
Take little more effort and cost more money as well, but this is not 2001 2002 by any means there is still plenty capacity deals are getting done. It remember our job is to mitigate this for our clients. So number one we're training our people across the globe.
Net out in front of this and explain to your clients that in fact in many instances. We can show you that your rates are lower today than they were in 2005.
So you've had a very good run this is not a knee jerk.
People at the rates that are being requested in many instances make a lot of sense, but it certainly not a message that anybody wants to hear now let me compare that with what a hard market is and again you got to back to 2001 2002, and that's when the door Slam shut you got people getting cancel left and right cancellation notices are going.
Out every month you are trying to explain to your clients, where they've been lost free and yet the X Y Z insurance companies not going to renew them and they better get ready for the consequences of significant deductible increases and possibly the reduction of limits on a drastic basis.
Frankly, that's not good for anybody.
I've been through three or four of those in my career and it's a little bit like going home and finding out the electric company just decided to change the current none of your appliances work.
And so that that's not good for anybody and I don't see that happening I do see disciplined need for rate and that is being explained by or professionals and where necessary. We're doing everything we can to help them find cover at a cheaper price.
Okay. So as a follow up then so if we can I get.
Maybe goldilocks.
Rates keeps drifting up by just a couple of points I mean, do you expect and the question we get from investors is.
Bill A.J. Gallagher continue to say, yes, its 50 basis points of improvement are obligated to six 7% organic territory.
Do you expect.
For more of the.
Organic to to fall to the bottom line.
Yes, Mike Yeah, I think that he got over 6% for our continued period of time, you would see you can see some more margin expansion than 50 basis points.
Okay, Great and just lastly for Doug.
On the M&A sandbox.
It's interesting there's been some ipos smaller companies that have been very successful on trading a nice multiples or something like one this week as well just that have any impact and in terms of maybe.
Making that another pipeline is robust, but maybe it removes some potential for some adult larger deals.
Yes, yes outlets these companies find out.
Just to go the IPO Rob.
Oh, I don't I don't know if it makes a dramatic different Tonight, I think remember people joining gallagher because they see our capabilities our resources, they now that being together with us.
That will be about our opportunity to deliver value to their customers.
The the folks that might want to IPO, our go to our financial sponsor.
That's really not what they're trying to do with their business the ones that we're trying to attract and when we get 40 50 60 of those folks a year that want to come in and and be better together. So it could happen, but I don't see at that point, a lot of folks away from us.
Thank you.
Thanks, Mike.
Our next question comes the line of at least.
Wells Fargo your with your question.
Hi, Thanks, Good evening Oh, My first question on at your Investor Day.
Kind of just a little bit over a month ago you lose it point you can you know I believe a little bit of a slowdown in organic in the third quarter. I know does I think you said you know last year was a tougher comp on obviously that the growth that you guys printed inline with what we had seen on two is the first six months so did.
Did some business outperformed relative to your expectations I'm, just trying to get a sense of what might have changed Dom you know not tons few weeks on 20 onto the Claire.
I think that we did have a good September job, yeah, we're talking about a few million Bucks airseal, but if you really look at places were particularly strong our UK in London operations are really killing it right now they're doing great. You saw good growth in Canada have you can go through work or Pat talked about where we're seeing so some left there but.
I think that that September is a big month for us as of December so.
And we did have a difficult comparison I was pretty proud of the team to grow over the top.
Okay. That's helpful and then on so as we think about on 2020 on you know it sounds like you guys are pretty optimistic in terms of what's going on with exposure growth as well as you know property casualty pricing momentum at least be maintained at its current level.
Okay do you does it seem like contino 2020 can be kind of in that 5.5% range that you're guiding to for the fourth quarter, just any kind of initial view there.
Yes, I think that tower C in 2020.
Summarizing the 5% remember they're also during this time of losses go up you could have some programs and need to reprice.
Awesome carry decide that at that that they're going to pull back on some staff. So it's the repricing piece, it's always hard for us to Ted take a look at this far in advance.
Okay. That's helpful and then on I appreciate getting that color on a clean energy earnings for on 2020.
There is that 20 million dollar range, which does seem a little bit higher than typical on I guess why is there a slightly bigger range and how should we think about I guess following towards the higher end versus the lower ended that range for next year.
Well for a long ways away there is still the utilities are still doing their budgets, we pull them here.
During the last month to see if we can get an early log. So we typically don't provide us to January so I'd expect to narrow that range, but also when you look at the utilization.
Coal for electric power sector production.
You know in 18 has been declining about 3% a quarter, maybe 4% a quarter, we had a big drop off in April and through June of this year and a second quarter Im just looking at some of the 10 things you can find out on the EA and where they were down 18% that's weather related more than any displacement.
But if you really think about it the line to look at as is the $50 million to $60 million, where the production related to those plants that were making US 56 to 58 million Ishare no. That's maybe a florida, 5% pull back in the numbers, maybe a little bit more but between 80 and 100 million we're still.
Really darn happy with us when we set out a 10 or 11 years ago to do this.
Investment strategy, the idea of us, making called the midpoint or a $90 million in the in the.
Ninth year that I don't think we would have dropped about so we're pretty proud of that that effort.
Okay. That's helpful and one last quick question your acquisition revenue I'm on page five for the fourth quarter and 116 million, that's about 21 million higher than what you guys had provided that that September IR day is that it's like one deal driving that from either that was announced in the fourth quarter is that you.
The compilation of some of the smaller deals you announced the fourth quarter to date that flow into the fourth quarter.
Okay can you just restate the question you're looking at something in the fourth quarter, our estimates for a role in revenues $116 million right. So that would you will yeah. So that's yes, that's 21 million higher than what you had told us at the IR day. So is that is there one big deal that you announced since then it.
Benefits the fourth quarter that much.
Just more a lot of deals that were announced on since September .
So I think some of its Q4 deals that came in call. It half with that's different than we closed Q4 deal and then also I think the JLTV Oh God Aerospace business, we've got a better line of sight on what we think's rolling and from that.
Okay. That's helpful. Thank you very much thanks actually.
Our next question comes the line of jargon <unk> with Goldman Sachs.
Good question.
Hi, good afternoon everybody.
First question is around the EBITDA adjusted EBITDAC margin and the brokerage business up quite a bit.
Year over year and.
Even seasonally seems to be.
Quite strong here and then if as I recall I think that you'd said in the past that.
Second half of the year has a little bit of weakness just because of the salary increases or compensation increases that come in.
And I'm looking out three years in a row, where in the third quarter is actually quite seasonally strong is there any change in how you're thinking about seasonality here any driver for a particularly strong result here.
Yeah, I think the biggest answer as of the team did a really nice job.
Kind of put the clamped on hiring add you know when we when you're hiring them.
350 people a month you can you can kind of control your comp ratio a little bit by just putting the breaks out a little bit we coming into the end of the air we didn't want to get too aggressive on our hiring thats, probably delevering most of that and the in the quarter, which is a little different than that typically we don't do that on a fourth quarter. So I think a team has got out of it.
Okay and do you think there is there's a timing issue here I would just think there was from end markets and opportunities maybe the hiring.
I'll still commence.
Yeah, we're always out there looking for producers we do we're always during that I think that you're really seeing some of the economies of scale coming through.
We didn't know we didn't do a rough and if you recall some of that that no I wouldn't call three or 300 people a wrap on 34000, but we did a tightening the belt and in June and July . So that's part of it but also we're just getting good results by utilization of our offshore centers of excellence, we're getting good result.
Through our technology left it just you'd get these economies of scale as you get a in as the business grows.
Okay.
And with that in mind, then as we look forward do these.
In the past you tell you anything about of about 4% growth should achieve what was it 30 basis points of margin improvement or 40 basis points margin proven 5% organic growth, we get a little more than that.
You should we expect an acceleration of that given my time here.
There's two things that we'll look at will look really odd the team Devin and terrific year. So we'll look at how the bonus or bonus expense looks in the fourth quarter I think that.
Yeah, we still feel comfortable for posting over 5% will get 50 basis points of margin expansion.
Okay.
The second question, if I, if I may contingent commissions.
If the industry is raising rates in a rational way basically to address inadequate returns I would think.
Should one expect a decrease in contingent commissions over the next 12 months.
Well from numerically contingent commissions you could have a little flattening in the growth of contingent commissions that we think about out and we got hundreds and hundreds of contingent commission contracts out there all around the world that sell a business that loss ratio sensitive, let's call it $50 million of annualize earnings.
Yes, it flattens out you probably get paid back.
For that in the base Commission and fee line as as as you get some rate left.
And some exposure left so overall in organic shouldn't suffer too terribly much based on what we're seeing the loss ratio environment right now.
Got it thanks, so much.
Sure.
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Our next question comes the line of Meyer Shields KBW. Please proceed with your question.
Great two quick questions. If I can I want to California, Ron's question and ask whether the deteriorating casualty environment that we're hearing a little bit about this quarter is translating into more claim more liability claims handling within risk management.
Well, there's no doubt I mean, we're seeing first of all we are seeing toward Inflations pad, we're seeing toward inflation across our book of business in particular in areas like transportation.
Sexual misconduct and ER and do you know in places like that.
Liability book and severity in the liability book at Gallagher Bassett, It's both up in terms of numbers of of claims as well as the the settlement amounts that are being paid to close.
Okay, and then I mean, theres clearly toward and for inflation.
Okay and that sounds like it was good for risk management revenues.
It should be because a big part of what we're trying to prove in the marketplace and realize we're getting to a size now as the risk management claims provider that many of our own trading partners don't handle the number of claims Gallagher Bassett does so we're trying to point to the fact, two carriers to captives and to risk management.
Clients that if they select Gallagher Bassett their results their results will actually be better. We we will have a better claim outcome than there used to in the general market and we do believe we can stand up to that so yeah. I mean as people start to feel the squeezed and this is the settlement costs go up more reason to listen to our stock.
Sure.
Okay excellent.
And second question I guess, if you look back I'm I'm interested in how accurate past surveys of client.
Gross have been in terms of predicting how the economy actually pans out really really good our feet. Our people are on the street. This is this is not a survey of a bunch of economists that are sit in Washington DC. These are people sitting across from customers right now planning for 2020.
And they're not going to be pine. This guy because the fact is when you tell us your payrolls in your exposure other exposure units sales are going up you're going to have a higher deposit on your insurance premium so there's a natural tendency to global.
Then if you lowball you get a free loan from the insurance company. So none of these to at least these guys really have a are there to the ground.
Okay. That's fantastic. Thank you.
Thanks, Matt Thanks room.
Your final question comes the line of Mark Hughes with Suntrust. Please proceed with your question.
Yes. Thank you good afternoon definitely.
Doug the 1.5 billion in capacity for next year could you refresh us on how much of that you would anticipate just to be free cash and then how much you would borrow and then what's your capital cost would you imagine on that the piece that you would be borrowing.
[noise] half would be free cash half would be a borrowing.
And on once our cost of borrowing on our 4%.
On a quarter or something like that.
And then just to be clear the a in the CFO commentary your estimate for revenue contribution that is entirely inclusive of all the deals you've done heretofore, including I think you said 90 million.
In the acquired revenue in the in October is that correct through yesterday, yes.
Yes sure Okay.
Great. Thank you very much benchmark thanks Mark.
Any others to them.
There are no further questions at this time, great that let me just make one quick quick comment to wrap it up but thank you again for being with US. This afternoon I'm extremely proud of what the team has accomplished so far this year and I believe we're poised to deliver a strong finish to the year. So thanks, everybody for being with US today, we appreciate it.
This does conclude today's teleconference. You may now disconnect. Your lines at this time. Thank you for your participation and have a wonderful day.