Aon plc (NYSE:AON) Q3 2023 Earnings Call Transcript

Aon plc (NYSE:AON) Q3 2023 Earnings Call Transcript October 27, 2023

Aon plc reports earnings inline with expectations. Reported EPS is $2.23 EPS, expectations were $2.23.

Operator: Good morning and thank you for holding. Welcome to Aon plc’s Third Quarter 2023 Conference Call. At this time, all parties will be in a listen-only mode until the question-and-answer portion of today’s call. I would also like to remind all parties that this call is being recorded. If anyone has any objection, you may disconnect your line at this time. It is important to note that some of the comments in today’s call may constitute certain statements that are forward-looking in nature as defined by the Private Securities Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. Information concerning risk factors that could cause such differences are described in the press release covering our third quarter 2023 results, as well as having been posted on our website.

It is now my pleasure to turn the call over to Greg Case, CEO of Aon Plc.

Greg Case: Good morning, everyone. Welcome to our third quarter conference call. I’m joined by Christa Davies, our CFO; and Eric Andersen, our President. As in previous quarters for your reference, we posted a detailed financial presentation on our website. As we begin the call today, we’d like to take a moment to reflect on the ongoing conflict in Israel and Gaza. We condemn violence anywhere that occurs in the world and remain highly concerned about all in harm’s way. The safety and well-being of our colleagues and their families is always our top priority. And our team is in constant contact with our leaders in Israel to ensure our colleagues, their families, and our clients have our full support. As we reflect on the quarter, we want to start with a huge thank you to our Aon colleagues around the world for all they do every day to support each other and to support our clients.

Turning to financial performance. We delivered strong results in the quarter that contribute to year-to-date progress against our key financial metrics. Organic revenue grew 6% in the quarter was highlighted by double-digit growth in reinsurance solutions and health solutions. Year-to-date 7% organic revenue growth and ongoing operational improvement have contributed to 80 basis points of adjusted operating margin expansion and 10% adjusted operating income growth a strong performance. In our solution lines. Reinsurance solutions delivered another very strong quarter of 11% organic revenue growth with strong growth across Treaty Fac and our Strategy and Technology Group. In addition to delivering a strong quarter, our team is already helping clients prepare for the 2024 renewals.

Health solutions also delivered another very strong quarter with 10% organic revenue growth as our team continued to drive strong new and renewal business. We see ongoing focus from clients to address underlying trends impacting their workforce and health care costs such as medical and wage inflation, population health, focus on well-being and overall talent engagement. Within wealth solutions, organic growth of 4% reflected strength in retirement as our teams continue to sell clients with pension risk transfer and regulatory change. Finally, commercial risk organic revenue growth of 4% reflected strong renewals and net new business with strength internationally in EMEA and the Pacific. However, overall organic revenue growth was negatively impacted by the external M&A and IPO markets as we communicated previously.

Today we’re also excited to announce actions to go further faster on Aon United and we will describe our plan and our restructuring program will accelerate key elements of our strategy. As always, our actions are driven by client need. For our clients the difficult reality of the current world is evident everywhere as they face increasing challenges, understanding, measuring and dealing with risk. Our forthcoming Global Risk Management survey details this trend with input from over 3,000 public and private clients of all sizes across geographies and industries. Trade, Technology, Weather and Workforce Stability are simple forces in today’s risk landscape. While each of these forces are individually impacting risk exposures, the increase in connectivity is compounding complexity and presenting new challenges to business leaders.

Responding to our clients’ increasing and evolving demand, they’ll protect and build their business we are advancing a series of actions to further accelerate our Aon United strategy. These actions taken over the next three years, will deliver outcomes that directly address client needs and demand. Specifically, we will improve the quality and availability and analytic tools available to clients, substantially improve their service experience and expand the quality and scope of solutions we bring to them. This work will put our clients in a much stronger position to make better decisions to support their companies. We will accomplish this by delivering on three commitments over the next three years. Internally, we call this 3×3 plan. The three commitments include: first, leveraging our risk capital and unit capital structuring capability to unlock new integrated solutions across our core business, but also address new requirements in client demand.

Second, embedding the Aon client leadership model across our enterprise clients in large and middle market segments to further strengthen and expand our client relationships; and third, accelerating Aon business services plan to set a new standard for service delivery and next-generation analytic tools. The benefits of this plan accrue to our colleagues, our clients and our shareholders. Colleagues win with greater capability to serve clients. Today our team is exceptional in their client leadership focus and impact, and this work provides them with next-generation tools and capability to serve clients and to meet increasing client demand. Clients win with better solutions and better service. This work resets client service to a higher standard and provides analytic tools and solutions required to meet demand, and investors win through our greater client relevance continuing margin improvement and sustained double-digit free cash flow growth.

And while we could have achieved these benefits over time, we have instead decided back now and accelerate a proven strategy. Let me describe where our team came to this conclusion. The last 10-plus years have demonstrated that a more connected firm is a more capable firm, and the connecting Aon is a done in concept that’s accomplished through meaningful structural change, which must be embraced and led by colleagues. It is cultural and only viable as a defining part of our DNA. And even though we remain on a journey, with plenty of distance to travel and opportunity ahead to improve, we have made progress and the results have been meaningful for clients in terms of innovation and support, for colleagues in the form of excitement and engagement currently at an all-time high and for shareholders measured by sustainable value creation including, a 30.8% full year 2022 operating margin compound free cash flow growth of 13% a year from 2010 to 2022 and return on invested capital at year-end 2022 of 30.6%.

However, two observations give us conviction that going further faster is a requirement. The first, is increasing client demand. And the second is, our execution confidence based on our proven track record the 3×3 action plan we have defined and the diligent work already underway. Accelerating our plan requires greater upfront investment. And as announced in our press release, we will execute this through a $900 million restructuring program, focused on two areas. First, is on accelerating our Aon Business Services plan by focusing on standardized operations integrating operating platforms and driving product innovation. And the second is, on workforce planning to align skills and capability required to deliver on the digital first opportunity embedded in AI business services as well as workforce changes to strengthen our client-serving capability and risk capital and human capital.

This investment will also drive $350 million of cumulative annual run rate savings by year-end 2026, which Christa will describe in more detail. Overall, our team is very excited about the opportunity to accelerate our plans to strengthen client leadership and fortunate that we have the opportunity and options to take this step as a direct result of the work of our colleagues. We continue to expect to drive mid-single-digit or greater organic revenue growth over the course of 2023 and the long-term. We further expect these savings will contribute to ongoing annual margin expansion. And while the program will impact free cash flow in the near-term, over the long-term, we expect to continue to deliver double-digit free cash flow growth driven by operating income and working capital improvements.

In summary, our strong year-to-date operational performance, including 7% organic revenue growth, 80 basis points of adjusted operating margin expansion, and 10% adjusted operating income growth, demonstrates strong momentum against our Aon United strategy. It creates the opportunity for us to double down on our strategic commitments around risk capital, human capital, our client leadership model, and Aon Business Services. These steps will enable us to continue to address evolving client demand, improve colleague outcomes, and continue our track record of long-term shareholder value creation. Now, I’d like to turn the call over to Christa for her thoughts on our financial results and long-term outlook. Christa?

Christa Davies: Thanks so much Greg and good morning everyone. As Greg highlighted, we delivered strong operating results in the third quarter and year-to-date. Through the first nine months of the year, we translated 7% organic revenue growth into 80 basis points of adjusted margin expansion and 10% adjusted operating income growth. These results position us very well to continue driving results in 2023 and over the long-term. We look forward to building on this momentum as we head into the last quarter of the year. As I reflect on our performance year-to-date, as Greg noted, organic revenue growth was 6% in Q3 and 7% year-to-date. We continue to expect mid-single-digit or greater organic revenue growth for the full year 2023 and over the long-term.

I would also note that reported revenue growth of 10% in Q3 includes a favorable impact from changes in FX of 2%, primarily driven by a weaker US dollar versus most currencies, compared to the prior year period. Reported revenue growth of 7% year-to-date includes an unfavorable impact from changes in FX 1%, primarily driven by a stronger US dollar versus most currencies compared to the prior year period. I’d also highlight fiduciary investment income, which is not included in organic revenue growth, with $80 million in Q3 and $196 million year-to-date or 3% of total revenue in Q3 and 2% of total revenue year-to-date. Moving to operating performance. We delivered strong operational improvement through the first nine months of the year with adjusted operating margins of 30.8% an increase of 80 basis points driven by revenue growth, efficiencies from Aon Business Services, overcoming expense growth, including investments in colleagues and technology to drive long-term growth.

We translated double-digit adjusted operating income growth into adjusted EPS growth of 15% in Q3 and 8% year-to-date. As noted in our earnings material, FX had an unfavorable impact of approximately $0.01 per share in Q3 and an unfavorable impact of $0.20 per share year-to-date. If currency remains stable at today’s rates, we would expect a favorable impact of $0.03 per share in the fourth quarter, totaling an unfavorable impact of $0.17 per share for the full year 2023. I’d also note the change in other nonoperating expense had a $0.15 per share or 7% unfavorable impact in Q3 and a $0.59 per share or 6% unfavorable impact year-to-date. This reflects an unfavorable impact from an increase in non-cash net periodic pension expense, as well as balance sheet FX remeasurement in the current period and a gain on sale of businesses in the prior year period.

Turning to free cash flow. Cash flow from operations decreased $3 million year-over-year, reflecting double-digit operating income growth, offset in part by higher cash tax payments as we mentioned previously and the negative impact to working capital in the third quarter caused by temporary invoicing delays associated with the implementation of a new system. Free cash flow decreased 4% to approximately $2 billion, primarily driven by a $77 million increase in CapEx. CapEx was elevated in the first nine months of the year compared to the prior year period as we executed a number of technology projects to drive long-term growth. And net CapEx could be lumpy quarter-to-quarter and we expect CapEx to moderate in the fourth quarter to total CapEx investment of $220 million to $250 million in 2023.

As we’ve said before, we manage CapEx like all of our investments on a disciplined ROIC basis and we expect it to grow the business going forward. Now let me share more details about our accelerating Aon United program. As Greg highlighted, we are doubling down on three strategic commitments, including accelerating Aon Business Services, which in turn enables us to unlock advancers in risk capital and human capital and our Aon Client Leadership strategy. Together, these commitments will drive more value for clients, colleagues and shareholders. The investment to accelerate our three-year Aon Business Services operating model focuses on the same three areas we’ve mentioned previously. We see proven benefit and will now accelerate. Number one standardized operating operations; number two integrating operating platforms; and number three increasing product innovation and development.

We’ve already made considerable progress in standardizing our operations but we see significant opportunity both within and across our solution lines. The work we’re doing to standardize operations will drive integrated service delivery platforms, which provide additional opportunities to standardize how we do business, and standard operations combined with integrated platforms enables more effective new product development and innovation at scale. By accelerating standardization across the portfolio and establishing fewer more integrated platforms, we’ll be able to deliver more analytical tools to colleagues and clients across the entire portfolio. With this underlying infrastructure in place, we’ll be able to leverage advances in AI and machine learning to further accelerate the product development cycle and unlock new efficiencies across the portfolio.

Let me provide a bit more financial detail about the strategic investment. We expect total annual in-year savings of $350 million to be achieved in 2026, contributing to ongoing sustainable long-term margin expansion. I’d note we expect savings to ramp over time with annual Indian savings expected to be $100 million in 2024, $250 million in 2025 and $350 million in 2026. We do not expect material savings or impacts to cash flow in 2023. Cash restructuring charges of $900 million reflects the savings ratio of 2.6 times and a largely to technology costs and workforce optimization. I’d note you can think of the $900 million cash restructuring charge as less than 10% of underlying free cash flow over the next three years and the $350 million of savings as a 4% cost takeout relative to our cost base of approximately $9 billion.

We also expect an additional $100 million of non-cash charges, largely related to asset and lease impairments. We do not expect significant incremental CapEx associated with the program and we expect CapEx will grow in line with the business in the future from our guidance of $220 million to $250 million in 2023. In the third quarter of 2023, we incurred $6 million of restructuring charges and we’ll communicate charges and savings going forward each quarter. Contemplating the program, as we look forward we continue to expect mid-single-digit or greater organic revenue growth for the full year 2023 and over the long-term. We expect program savings will contribute to ongoing sustainable long-term margin expansion and expect to deliver margin expansion in 2023, 2024 and over the long-term.

As we’ve noted previously, over the last 12 years we’ve delivered 1,120 basis points of margin expansion or about 90 basis points a year on average. Our outlook for free cash flow remains strong. We expect to deliver high single-digit free cash flow in 2023. I’d note this guidance contemplates the impact from restructuring on free cash flow in Q4 so we do not expect restructuring to have a material impact on cash flow this year. While free cash flow will be reduced in the near-term by restructuring we expect to return to our trajectory of double-digit free cash flow growth over the long-term driven by operating income growth and ongoing working capital improvements. As we’ve said previously, as we look at the opportunity in Aon Business Services and across our client-facing capability we know that delivering this strategy will result in long-term progress against our key financial metrics: organic revenue growth margin expansion and free cash flow growth.

Now turning to capital allocation. Given our strong outlook for free cash flow we expect share repurchase to continue to remain our highest return on capital opportunity for capital allocation. We believe we’re significantly undervalued in the market today highlighted by nearly $2 billion of share repurchase year-to-date. We also expect to continue to invest organically and inorganically in content and capabilities that we can scale to address unmet client needs. Our M&A pipeline continues to be focused on our global priority areas that will bring scalable solutions to clients growing and evolving challenges. We will continue to actively manage the portfolio and assess all capital allocation decisions on an ROIC basis. Turning now to our balance sheet and debt capacity.

We remain confident in the strength of our balance sheet and manage liquidity risk through a well-laddered debt maturity profile and expect to add incremental debt as EBITDA grows over the long term while maintaining a strong investment-grade credit profile. In summary, our strong financial results in the quarter and year-to-date reflect strong operational performance driven by our Aon United strategy and our Aon Business Services platform. We see an opportunity to accelerate the next stage of our Aon United strategy and expect this investment will contribute to sustainable long-term top and bottom line growth and ongoing shareholder value creation. With that I’ll turn the call back over to the operator and we’d be delighted to take your questions.

Operator: Thank you. [Operator Instructions] Our first question is from Rob Cox with Goldman Sachs. Please proceed.

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Q&A Session

Rob Cox: Hi. Thanks for taking my question. Just curious on the free cash flow. I just want to make sure I understand what exactly is driving the lower free cash flow guide? Because it sounds like the restructuring is it material this year and you mentioned the invoicing was a temporary issue. So just trying to understand what exactly is driving the guide lower.

Christa Davies: Yeah. It’s really about the temporary invoicing delay Rob. We had that in Q3. And while we’re addressing the system issue, we could continue to see temporary impacts to working capital in the fourth quarter.

Rob Cox: Okay. Got it. Thank you. And just on the restructuring program, just compared to your history with these programs and some peers the 2.6x saving ratio maybe seems a little conservative for a program that includes an element of workforce rationalization. So just curious if as management views it that way and if we could potentially see more savings come to light beyond the $350 million?

Greg Case: Rob, we’re glad you asked the question. We appreciate it. Listen I think it’s worth stepping back here a little bit and really making sure you understand exactly what we’re trying to get accomplished here because this is different than anything you certainly ever had seen from us before and we’re very excited about it. We’ve said before, look our clients and our colleagues they’re demanding better solutions. You’re seeing it every day the survey, I described identified some of the challenges they see really around risk capital beyond our solution lines and human capital. And to be clear, we’re delivering on those solutions through Aon United, but they’re demanding we go further faster and they’re asking us about this.

Our colleagues see it and they’re incredibly excited about our ability to deliver on it. And for us, the opportunity is clear. We’ve got Aon Business Services. We’ve got the platform in place. We have a long way to go on it, but supported by 15,000 colleagues we know we can accomplish this objective around clients and we can do it faster and accelerate the strategy and build a stronger client-facing terms. So that’s basically the focus of what we’re trying to do. And to be clear, this is easy to say but hard to do. I mean, data analytics the operating platforms have all got to be connected and integrated teams have got to be aligned to accomplish the goal and that’s exactly the path we’re on. And now we’re going to accelerate it. And as Christa observed for a firm that really obsesses around return on invested capital, we believe this investment is going to be one of the most compelling ever.

But I’m thinking Eric to bring it to life it’s just so important everyone understands exactly what we’re doing. How does this show up from a client standpoint in your view?

Eric Andersen: Sure, Greg. And maybe I’ll do to an example might be the easiest way to bring it to life because it’s evolving so quickly that as clients are looking at these exposures and these developments, they’re pressing us for more insight more analytics and maybe just one that’s come to mind around climate which is such a topic today. We had a client in Asia Pacific that was looking at severe weather and how it was going to affect their loan portfolio, how it was going to affect their future financial obligations in terms of disclosure. And we engage with them because they had asked us about their future. They asked us about the physical climate risk that was coming. But as we began to talk to them, they were really starting to press for a baseline of their loan exposures today, which required climate analytics that are cutting edge and are really just coming to the fore.

And so what they’re doing with it today is they’re looking at integrating their climate analytics into their risk modeling themselves, as they go forward as a business. And I guess the point of it is, that capability as it’s being developed and being brought to the market, really allows all types of clients to look at climate physical risk, put it into their own business model as they go forward, but they’re starting from one place and often ending in another. But to be able to deliver those analytics in the form that they can use to be able to build their own business, Aon Business Services provides that engine to be able to aggregate the data to be able to put it in usable format going forward. So we’re really excited about what this gives us and the ability to replicate that across the globe as financial institutions of all type are being pressed to understand their climate risk.

Christa Davies: And then just in terms of the financial piece Rob, it is $900 million of cash restructuring charge to deliver $350 million of savings in year in 2026. We don’t expect to go above that guidance. We do expect in terms of financial guidance to continue to expect mid-single-digit organic revenue growth or greater for the full year 2023 and over the long-term. We expect to deliver adjusted operating margin for the full year 2023, full year 2024 and over the long-term, and we expect these program savings will contribute to ongoing sustainable long-term margin expansion. And then while free cash flow will be impacted in the short-term, we expect to return to our trajectory of double-digit free cash flow over the long-term, driven by operating income growth and ongoing working capital improvements.

And then lastly as Greg said, we look at all of these investments across Aon on a disciplined ROIC basis. And I want to reiterate, we focus intensely on cash and we think about all investments on this disciplined basis. This investment is no different. It will name us to accelerate the work we’re doing across the firm and ultimately contribute to great long-term shareholder value creation across our key metrics in line with our track record.

Rob Cox: Thanks. Appreciate all the color.

Operator: Our next question is from Paul Newsome with Piper Sandler. Please proceed.

Paul Newsome: Good morning. Thanks for the call. Congratulations on the quarter. I wanted to ask about whether or not the restructuring charge here, the cost savings from the restructuring charge that we’re looking at is really additive to the ongoing margin improvement? In other words, would you need to have – do you need to have this effort to continue that margin expansion? I think given how good the margins are people sometimes wonder if there’s a limit here and if you more extraordinary things need to happen to continue to have that margin expansion.

Christa Davies: Thanks so much for the question, Paul. And look, the way we think about financial guidance going forward is mid-single-digital greater organic revenue growth in 2023 in the long-term, margin expansion in 2023, full year 2024 and over the long-term and then double-digit free cash flow growth long-term. We do expect this program to help us accelerate the strategy and we expect the savings to contribute to margin expansion next year. But what we’d also say is we think about margin expansion holistically, Paul. And so each year we’ve continued to say this. We have a gross margin expansion that’s higher than what we met, generate for shareholders and we continue to invest. And you’ve seen that in calendar year 2023 as well, where we’ve continued to invest in technology, you can see technology expenses up CapEx, where we’re investing in long-term technology platforms to drive long-term productivity.

And so we’re investing in a long-term strategy as we generate great results for shareholders each and every year.

Greg Case: Maybe I would just add one other point on this Paul. When you think about the margin, we often get asked about this is, it’s almost like it’s treated like a zero-sum game, the split between clients and colleagues and shareholders. We don’t see it that way. We see it around value. The example Eric described is really around incremental value to a client, asking a question they hadn’t asked before, we provided an insight around analytics. That simply is not possible without Aon Business Services on a scale basis. We provide incremental value. We get obviously compensated for that. That actually – that contribution is really what drives margin over time. So greater value means more margin. And so that’s what you’re hearing today sort of how we’re going to invest create greater capability to deliver more value for clients and that really is the engine around margin improvement, which is why we’re so confident now even more so with this investment to continue margin improvement over time.