Insurance Pricing And Risk Management Trends Will Support Solid Long Term Performance

Catalysts

About Arthur J. Gallagher

Arthur J. Gallagher is a global insurance brokerage and risk management firm providing property and casualty, reinsurance and employee benefits solutions.

What are the underlying business or industry changes driving this perspective?

• Although the integration of AssuredPartners expands distribution reach and cross-selling opportunities, the pronounced seasonality and lower initial margins of the acquired book could mute near term operating leverage and limit upside to revenue growth translating into accelerated earnings per share.
• Despite continued positive pricing in casualty and workers compensation, a broadening softening in property and certain financial lines could gradually compress brokerage commission yields, slowing top line growth and constraining adjusted EBITDAC margin expansion.
• While demand for sophisticated risk management, analytics and outsourced claims solutions should structurally support Gallagher Bassett, intensifying competition and carriers building in house capabilities may cap pricing power and temper net margin improvement in the Risk Management segment.
• Although long term needs for employee benefits consulting and strategies to manage medical cost inflation remain robust, employers facing persistent healthcare and labor cost pressures could trade down on advisory scope, limiting fee growth and dampening operating margin gains in the benefits franchise.
• While the company has significant balance sheet capacity to pursue further M&A, higher deal multiples, integration complexity from layering another large platform on top of AssuredPartners and slower synergy realization could dilute return on invested capital and delay accretion to earnings.

Assumptions

This narrative explores a more pessimistic perspective on Arthur J. Gallagher compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Arthur J. Gallagher's revenue will grow by 19.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 13.3% today to 15.0% in 3 years time.
• The bearish analysts expect earnings to reach $3.1 billion (and earnings per share of $11.65) by about December 2028, up from $1.6 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $5.0 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 25.7x on those 2028 earnings, down from 39.7x today. This future PE is greater than the current PE for the US Insurance industry at 13.1x.
• The bearish analysts expect the number of shares outstanding to grow by 0.82% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.96%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• If the company successfully realizes the targeted 160 million of annualized run rate synergies by the end of 2026 and up to 280 million by early 2028 from AssuredPartners integration and wider technology deployment, operating leverage could be higher than expected. This could drive faster expansion in adjusted EBITDAC margins and accelerate earnings growth.
• The long term strategy of combining a high volume tuck in acquisition pipeline with a very large balance sheet capacity of around 10 billion for further M&A, alongside a strong cultural integration track record, could sustain double digit total revenue growth for many years. This could lead to structurally higher revenue and net earnings than implied by a flat share price view.
• Persistent mid single digit organic growth across Brokerage and Risk Management, supported by secular demand for sophisticated risk advisory, reinsurance solutions and outsourced claims management, combined with Gallagher Bassett margins holding around 21 percent or better, could underpin compounding earnings per share growth. This could make a stagnant share price increasingly unlikely.
• If global insurance pricing stays positive overall with continued 4 to 5 percent renewal premium increases outside of property and steady 6 to 8 percent casualty rate increases, while clients also opt in to buy more coverage as pricing eases in some lines, the company could see stronger than expected organic revenue growth and healthy brokerage commission yields.
• Ongoing investment in data, analytics and AI, such as the integrated data lake and tools like Gallagher Drive, together with the expanded international reinsurance and specialty footprint, could enhance competitive differentiation and win rate over time. This could improve client retention and new business wins and support higher long run revenue growth and net margin resilience.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Arthur J. Gallagher is $250.0, which represents up to two standard deviations below the consensus price target of $308.4. This valuation is based on what can be assumed as the expectations of Arthur J. Gallagher's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $388.0, and the most bearish reporting a price target of just $250.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $20.8 billion, earnings will come to $3.1 billion, and it would be trading on a PE ratio of 25.7x, assuming you use a discount rate of 7.0%.
  
• Given the current share price of $247.62, the analyst price target of $250.0 is 1.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.