We have reiterated our Neutral recommendation on Marsh & McLennan Cos. Inc. (MMC) based on the current sustainability factor. Marsh & McLennan reported its third quarter operating earnings per share of 24 cents, which came in line with the Zacks Consensus Estimate, but was lower than 27 cents reported in the year-ago quarter.
Marsh & McLennan posted improved results on account of top-line growth in all lines of businesses that also drove the operating margin. Most of these upsides were offset by higher operating expenses along with tax expenses.
Marsh & McLennan has a history of outperforming its peers due to its size, diverse product offering, global presence and technical expertise, thereby giving stiff competition to arch-rivals such as Aon Corp. (AON). The company’s broking and consulting divisions of Guy Carpenter, Mercer, Marsh and Oliver Wyman have been modestly contributing to the fundamental growth. We believe a stable economy and improvement in the insurance cycle should help boost both the insurance brokerage and consulting business.
Besides, Marsh & McLennan’s steady earnings growth and improved operating cash flow continues to support debt reduction and capital deployment effectively. This has also helped in diminishing the interest expenses and in de-leveraging the balance sheet. While the company’s expanded stock buyback program and dividend increment boosts investors’ confidence, its refinanced debt portfolio extends its maturity ladder, lowers the risk profile and reduces the interest costs, thereby mitigating operational risks.
On the flip side, Marsh & McLennan is encumbered with significant pension obligations toward its employees that mounted to $11 billion at the end of 2010. This is also reflected in higher compensation and benefits costs, including increased pension costs and higher consulting costs, which in turn poses additional burden on the financial leverage while also influencing the debt credit ratings. Additionally, it could also hurt the company’s investment portfolio and impede the process of raising capital in future.
In relation to the past, generating new business and client retention have also become difficult as clients now choose to diversify their business among multiple brokers in order to achieve pricing power and as a hedge against further abuse by a broker. This in turn increases the competition against other brokers as well.
Besides, external factors such as weak property-casualty market amid the soft pricing environment and an increasing tendency for risk retention by the clients have been compounding the stress created by these internal problems. Even the fee-based business has been of little help in attaining the targeted growth.
Increased dependence on international business further raises caution on currency fluctuations, interest and tax rates. Moreover, with a chain of acquisitions comes the risk of integration, primarily amid the volatile global economic scenario.
Given the pros and cons, the Zacks Consensus Estimate for the fourth quarter is projected at 46 cents per share, a nickel higher than the year-ago quarter. For 2011, earnings are projected to be $1.76 per share, about 7% higher over 2010.
Additionally, the quantitative Zacks Rank for Marsh & McLennan is currently #3, indicating no clear directional pressure on the shares over the near term.
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