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Brown & Brown, Inc.
/ (BRO - NYSE) ($45.87)All the changes since last update are highlighted in yellow
Overview
Based in Daytona Beach, Florida, Brown & Brown, Inc. (BRO), and its subsidiaries offer a broad range of insurance and reinsurance products and services, as well as risk management, third party administration, and managed health care programs. BRO markets and sells insurance coverage on behalf of its predominately commercial customer base through two distinct segments, retail brokering and a wholesale National Programs division. The former places insurance coverage for commercial, professional, and individual accounts. National Programs division designs proprietary liability, property-casualty, life, and health coverage for various professional and trade groups. In addition, the company operates as a third-party administrator (TPA) for workers' compensation and employee benefit plans (the Service division) and as a general agent for certain hard-to-place liability coverage (Brokerage division). BRO's specialty lies in the profitable and highly fragmented middle market (accounts with $2,500 to $150,000 in annual insurance commissions). BRO is the ninth largest broker in the U.S. (in terms of revenues), generating more than $500 million in commissions annually. The company provides its services through more than 120 company offices in thirty states and employs around 3,500 people. Business Insurance magazine has ranked BRO as the nation’s eighth largest independent insurance intermediary organization. Its website is http://www.brown-n-brown.com/
Management stated that the company’s outstanding record of earnings per share growth of 15% or more continues for the twelfth straight year. BRO has achieved its last interim goal, 'Project 28,' during the year and continues to aggressively pursue its goal of achieving, over the coming years, “B- 40”, $1 billion in revenue and a 40% operating margin (pre-tax income with interest and amortization expense added back).
During 2004, BRO has been favored by an exceptional caliber of organizations, and it continues to see a large number of potential new opportunities that will carry its brand to masses.
Investment Thesis
Analysts have identified the following factors for evaluating the investment merits of BRO.
Key Positive Arguments / Key Negative Arguments· Completed more than 19 acquisitions and aggressive acquisition trend expected to continue.
· BRO has a strong management team. Its organizational structure is superior to most of its peers, with the ability to maneuver through difficult periods.
· BRO is well capitalized to continue its proactive acquisition spree during 2005, due to continued cash flow growth, plus a strong cash and investment position.
· BRO continued blocking & tackling allows it to generate solid growth trends, despite more difficult pricing.
· Acquisition of Hull and Company will greatly enhance BRO’s wholesale brokerage operations.
· Combination of a robust M&A pipeline, significant exposure to Florida, and an unrelenting focus on winning new business will lead to strong revenue and earnings growth in 2005.
· Some analysts believe BRO’s organic revenue growth is among the highest in the insurance brokerage sector in 2005.
· BRO is expected to increase its compensation structure as a means of ensuring staff retention. / · Revenue growth and earnings power could be negatively impacted by ongoing soft market conditions.
· A prolonged downturn in premium rates could reduce financial profile of the business, as more than 90% of BRO’s revenues are from commissions paid by insureds.
· Inability to supplement internal growth with acquisitions could cause revenue and EPS shortfalls, especially in a difficult pricing environment.
· BRO faces the challenge of margin expansion, as expenses have crept up to above average levels.
· A structural change in the payment of contingent commissions as well as headlines surrounding the issues could hamper above average growth in revenues and earnings.
Total Revenue
Fiscal Year Ends: December$ in millions / 4Q04A / FY2004A / 1Q05E / 2Q05E / FY2005E / FY2006E
Commission & Fees / $158.4 / $638.3 / $194.5 / $197.3 / $795.9 / $881.8
Investment Income / $1.1 / $2.7 / $1.1 / $1.0 / $3.9 / $4.5
Other Revenue / $3.6 / $6.0 / $0.4 / $0.5 / $2.0 / $1.9
Total Revenue / $163.0 / $646.9 / $196.6 / $198.7 / $787.7 / $888.1
Total revenue for the fourth quarter of 2004 was $163.0 million, an increase of 20.9%, compared to 2003 fourth-quarter revenue of $134.9 million. Reported commissions and fees were $158.4 million in the quarter, up 20.3% versus the prior year quarter, driven by business acquired during the past 12 months. Core commissions and fees (excluding contingent commissions and divested businesses) increased 25.8% over the prior year quarter, with 5.5% organic growth. Program business continued to be a large driver of internal growth, though in the quarter the Brokerage and third party administrative (TPA) services segments (which make up a smaller percentage of commission revenue) contributed excellent growth. The Florida Retail segment produced strong organic growth of commissions and fees at 8.4%, compared to 1.6% in the third quarter, 3.7% in the second quarter and 7.7% in the first quarter. Outside of Florida, organic growth was mixed, with -3.8% growth in Western Retail, and 3.8% growth in National Retail. Professional Programs increased 9.1% and Special Programs internal revenue grew 5.3%. The smaller Brokerage segment posted strong organic growth of 20.5%, compared to 6.5% in the third quarter, 16.1% in the second quarter and 12.1% in the first quarter, and the TPA Services group continued to generate solid internal revenue growth at 13.2%. The analyst (Legg Mason) anticipates that commission and fee revenues will rise 14.2% year-over-year to $187.7 million in 1Q05, driven by a successful acquisition strategy and modest internal growth. Total revenue estimates are $190 million. The analyst (J.P. Morgan) believes that the long-term trend remains unfavorable, as capacity continues to increase and rate levels flatten or decline in most of BRO's target markets. Their current model contemplates a flat organic growth rate into 2005, adding more importance on M&A activity. For the full year of 2004, total revenue was $646.9 million, compared to $551.0 million, an increase of 17.4%. The analyst (Legg Mason) estimates full year revenue will be $794.4 million in 2005.
Please refer to Zacks Research Digest spreadsheet for specific revenue estimates.
Margins
Fiscal Year Ends: December$ in millions / 4Q04A / FY2004A / 1Q05E / 2Q05E / FY2005E / FY2006E
EBIDTA margin / 36.4% / 38.3% / 40.7% / 39.3% / 38.9% / 39.5%
Pretax Margin / 28.7% / 32.0% / 33.2% / 32.0% / 31.3% / 31.9%
The company produced an industry leading EBITDA of 36.4%, slightly down y-o-y from 36.5%, due to lower contingent commissions. The Ferris Baker Watts analyst looks for margins to increase slightly in 2005 (EBITDA margin of 39.1%, compared with 38.3% in 2004). The Cochran Caronia analyst has increased estimated 2005 EBITDA by 10%, due to the Hull acquisition and expectation of higher than expected contingents. The analyst (Legg Mason) estimates in 2005 internal growth and EBITDA margin will be 3.5% and 37.9% respectively, assuming a relatively stable insurance environment for a small and mid-sized commercial market like BRO.
A pretax operating margin was reported at 28.7%, from 30.6% a year ago. The biggest impact came from a higher interest expense that was caused by BRO’s recent $200 million borrowing. The company remains steadfast in its cost discipline. The J.P. Morgan analyst expects BRO's margins to continue to rise in 2005 and 2006, as newer agencies and producers are fully integrated into the BRO culture. It is important to note the Hull deal represents roughly 10% of prior year revenues, a transaction adding low execution risk for management.
Please refer to Zacks Research Digest spreadsheet for specific margin estimates.
Net Operating Income
Fiscal Year Ends: December$ in millions / 4Q04A / FY2004A / 1Q05E / 2Q05E / FY2005E / FY2006E
Digest High / $30.3 / $128.8 / $45.2 / $40.8 / $158.1 / $187.3
Digest Low / $30.3 / $128.8 / $35.1 / $38.8 / $150.0 / $167.7
Digest Average / $30.3 / $128.8 / $40.6 / $39.3 / $153.1 / $175.8
Net operating income for the fourth quarter of 2004 was $30.3 million, an increase of 17.4% over the $25.8 million, reported for the same quarter of 2003. Net operating income for the year 2004 was $128.8 million, versus $110.3 million in 2003, showing an increase of 16.8%.
Please refer to Zacks Research Digest spreadsheet for more details on net income estimates.
Earnings Per Share
Fiscal Year Ends: December$ per share / 4Q04A / FY2004A / 1Q05E / 2Q05E / FY2005E / FY2006E
Zacks Consensus average EPS / $0.43 / $1.86 / $0.59 / $0.57 / $2.16 / $2.50
Digest Average EPS / $0.43 / $1.86 / $0.58 / $0.57 / $2.17 / $2.18
Digest High EPS / $0.43 / $1.86 / $0.63 / $0.60 / $2.23 / $2.25
Digest Low EPS / $0.43 / $1.86 / $0.50 / $0.55 / $2.07 / $2.15
Management Guidance
The fourth quarter operating earnings were $0.43, compared to $0.37 posted during the last quarter of 2003, and better-than-consensus EPS estimate of $0.41. A lower-than-expected tax rate of 35.4% provided most of the upside, along with approximately $3.6 million of other (non-commission) income. Full year 2004 operating EPS was $1.86, compared to $1.60 in 2003, an increase of 16.25%. This was the twelfth consecutive year that BRO’s EPS has increased by at least 15%. The financial performance reflects solid organic growth, active acquisition activity, and unrelenting cost discipline.
Most analysts have increased their EPS estimate to reflect stronger than expected revenue growth and the closing of the Hull & Company acquisition.
Please refer to Zacks Research Digest spreadsheet for more extensive EPS figures.
Target Price/Valuation
Target prices for BRO range from a low of $42 given by the Keefe Bruyette analyst, who has the stock rated Neutral, to a high of $54 given by analyst (Stephens Inc.) who is Positive on the stock. The most common method of arriving at the target price is a combination of P/E ratio and estimated cash EPS. At the low end, the analyst (Keefe Bruyette) used 16 x 2005E Cash EPS of $2.67 to arrive at the target price. The analyst with highest target price (Stephens Inc.) used 17.3 x 2006E Cash EPS of $3.11.
Our digest average price target is $49.00 per share.
Rating Distribution
Positive / 22.22%Neutral / 77.78%
Negative / 0.00%
Average Target Price / $49.00
Digest High / $54.00
Digest Low / $42.00
Number of Analysts / 9
Risks to the price target include demand for insurance products, interest rates, and adverse economic conditions.
Please refer to Zacks Research Digest Spreadsheet for further details on valuation.
Upcoming Events
1. April 19, 2005 – BRO expected to announce 1Q FY2005 results.
Other Discussion/Capital Structure/Cash Flow/Solvency/Governance
The company completed 19 transactions, representing some $103 million of annualized revenues, in 2004. Five transactions have already been consummated in 2005, including private wholesaler Hull & Co., which generates approximately $63 million in annual revenues.
On February 11, 2005, BRO announced that it had signed a definitive agreement to acquire Hull & Company, a top 10 wholesale broker. Hull has approximately $63 million in annual revenue, generates EBITA margins of roughly 38%, and its history and culture is very similar to BRO. The deal in combination with the company’s existing business and recent acquisitions in this area will give BRO a brokerage revenue base of roughly $125 million. The deal was closed on March 3, 2005, on completion of the Asset Acquisition of Hull & Company, Inc. The Sandler O’ Neill analyst expects the benefits from the Hull acquisition to include a faster than expected acquisition pace, potentially greater acquisition activity for the year and higher operating margins.
Long-Term Growth
BRO remains one of the best long-term holdings in the insurance brokerage space, given its strong management team and aggressive sales culture. The tougher insurance market also implies that smaller brokers will be increasingly interested in partnering with national houses, which plays to BRO's strength as an aggressive, yet disciplined, acquirer. Relative to several of its peers that focus exclusively or significantly on Fortune 1000-type business, BRO's preferred area remains the middle market, for which much rate pressure vis-à-vis the largest accounts, is not expected.
BRO has a strong track record going back several economic and P/C underwriting cycles. In each of the past 10 years BRO has met or exceeded quarterly EPS estimates, with a 15% - plus growth rate. It is expected that BRO will excel in the current operating environment. Analysts believe that the outlook for BRO’s business remains bright, and the average long term growth rate of 16% is achievable.
Due to the M&A activity and the strength provided by Hull, BRO should be able to produce strong results from the rest of its business. Florida business will be the leader for BRO, as firmer P&C rates and significant levels of construction and other activity drive growth.
The SunTrust Robinson Humphrey analyst estimates that BRO will generate nearly 15% net EPS growth over the next few years, but also expects pricing pressures will continue to mount in 2005, placing a greater emphasis on acquisitions to meet BRO’s 15% earnings growth objective. The analyst (J.P. Morgan) estimates the all cash deal will contribute to a sustainable 15%-plus revenue and earnings growth through 2006. The analyst also believes that the transaction reinforces their positive view on consolidation within the middle market P&C insurance broker segment – a key driver of financial performance in the soft market environment.
The long term growth rate estimates range from a low of 15% (Ferris Baker Watts, Keefe, Bruyette & Woods) to a high of 17% (SunTrust Robinson Humphrey). The long term growth estimates of EPS for BRO is 15.67% (approx.).