Is Aon Stock A Buy?

Aon PLC (NYSE:AON) is an Irish insurance company headquartered in London, United Kingdom. It provides insurance, pension, and health insurance products around the world.

In March 2020, it announced a $30 billion merger with Wills Towers Watson that would make it the world’s largest insurance broker if approved. With a mega-merger on the horizon, is Aon stock a Buy?

The first thing to figure out is whether insurance is a good business to invest in. A clue to that answer can be found in the wealth accumulated by the most successful investor of all, Warren Buffett. While most novice investors think he’s simply a savvy stock picker, the reality is most of his fortune was made by investing in insurance.

These days, a slew of technology enabled insurance companies are gaining headlines, among the most prominent being Lemonade (LMND). They clearly see an opportunity to carve out market share from the big industry gorillas. The question is whether Aon is at risk from them?

Aon + Wills Towers Watson Merger

Shareholders approved the merger in late August, and the company’s power will be undeniable should government regulators approve it. In fact, that decision alone is likely to drive the company’s market value well into 2021.

The company still hasn’t fully recovered to is pre-coronavirus price levels, so investing while it’s still under a $50 billion cap could prove to be a value for investors soured by a rough 2020.

Financial and health insurance are sure to play major roles in the recovery of the next few years. Let’s examine the evidence to determine if Aon is worth its premium.

Aon 101

Aon is a large insurance conglomerate. It offers a variety of products to provide insurance for a vast array of life’s needs: financial security, health, and life insurance.

The company’s business model is based in risk mitigation, and success is measured in loss ratios. Loss ratios are the difference between how much money a company collects in insurance premiums versus how much money it pays out for losses.

Acceptable loss ratios are regulated and monitored by a variety of government watchdogs at both a state and federal level. It all depends on the type of insurance product.

Because this financial industry is so complicated, it’s often overlooked by all but the best number crunchers. It’s one of the reasons Buffett got involved. As a master “quant” and statistician he is able to better understand probabilities, odds, expectancies, and risk than most. Positioning his star student, Ajit Jain, at the helm of his golden goose insurance division at Berkshire Hathaway (BRK.A) didn’t hurt results either.

Aon is less about a single star leading the company as much as it is a collection of quants crunching the numbers to evaluate risk on a daily basis. And unfortunately the combined results were poor when the pandemic hit.

The company temporarily reduced staff pay to mitigate operational losses. This helped it quickly rebound from the pandemic-induced market crash and enabled Aon (AON) to beat analyst expectations through the year.

That’s all well and good for existing investors, but should you buy into Aon now that it already experienced so much of an upswing?

Is Aon Stock A Buy?

Aon PLC shares have traded at a P/E of 25-30x most recently. For an insurance company that suggests the company is fairly valued and a discounted cash flow analysis corroborates that. The AON intrinsic value is $220 per share.

Of the thirteen analysts covering the company, five rate it a buy while eight deem it a hold.

Its second-quarter earnings reported in August showed earnings per share of $1.96, which beat analyst estimates by over two percent. It also provided a 51.6 percent return on equity to investors in the period, versus the 25.9 percent industry average.

Much of the company’s growth over the years is through acquisitions, and the merge with Tower Wills adds an automatic boost to its assets and revenue sources.

Plus, Aon has already spent $1.5 billion on restructuring costs in the past two years. In fact, debt may weigh down its books and potential gains for investors.

Aon Long-Term Debt Is A Concern

The biggest looming problem is the company’s long-term debt. While it did pay it down from 71.3 percent to 68.4 percent from May through August 2020, it’s still too far above the 55.1 percent industry average.

Its current year earnings are underperforming the industry average too, giving bearish investors more fuel to add to their fire. And that’s just the financial problems – there are underlying social and economic issues that will come to forefront in 2021.

Employment-related claims are going to be a big issue in the coming years. There’s a high level of unemployment and many who are working do so as independent contractors without benefits. Social security is strained, and losses are expected in the coming years.

Whether Aon is stuck holding the bill for these losses depends on how well it can navigate the market and potentially dispose of poor yielding assets while snapping up high yielding books of business. If it can maintain favorable loss ratios while still bringing in premiums, the company has potential to rebound with aplomb.

Being the biggest kid on the block doesn’t come without rivals though.

Aon Is In A Competitive, Fragmented Insurance Market

Aon is consuming its competitor Willis Towers Watson, but it still has plenty of competition. Companies like Marsh & McLennan Companies, Gallagher, and Jardine Lloyd Thompson are all jockeying for position in the insurance lanes the company operates in.

Baby Boomers are already retired, and Generation X is quickly following them. This large aging population is going to put a strain on the retirement system. And there’s not much of a government safety net in place to help out.

This could put Aon in a position to lose bigger than its more-nimble competition. It also opens the floodgates for tech-based startups to overtake it. The insurance industry is notoriously slow to adopt technology, as evidenced by the health insurance marketplace and how Lemonade rose from nowhere to take on a legacy industry.

It’s in a profitable business, but those profits aren’t guaranteed to go to Aon, especially over the next five to ten years.

Is Aon Stock A Buy? The Bottom Line

Aon PLC is on its way to becoming the largest insurance broker in the world. It handles a wide range of risk mitigation products for both individual and group insurance plans.

It also routinely expands through an aggressive acquisition strategy that culminated in a recent acquisition of its rival Willis Towers Watson.If approved, there are big windfalls in store for shareholders. But don’t count your chickens before they hatch.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.