Company Reports

We have initiated coverage of Arthur J Gallagher. We assign the company a narrow moat rating and a fair value estimate of $250 per share. We see shares as modestly overvalued, as we think the market is overly focused on the recent tailwinds Gallagher and its insurance brokerage peers have been enjoying.

Gallagher is somewhat of a tollbooth business. The company enjoys sticky customer relationships and its revenue is driven by insurance transactions, which are stable as most insurance purchases are non-discretionary. Since its fees are often set as a percentage of premium levels, it does have some exposure to the insurance pricing cycle, but revenue for the business is still fairly steady. The company’s cost structure is flexible, and capital needs are minimal. The net result is relatively healthy and stable free cash flow.

Weak insurance premium rates and a sluggish employment recovery weighed on revenue in broker Arthur J. Gallagher's AJG second quarter, but we remain impressed by the firm's cost controls and overall resilience in the difficult environment. Overall revenue rose just 1% from the second quarter of 2009, as acquisition contributions offset somewhat improved but still weak internal revenue. Commissions and fees were off 3% excluding acquisition effects in Gallagher's brokerage segment, while fee revenue was down 2% on the same basis in Gallagher's risk-management division (one of the largest third-party claims administrators in the world).

Insurance brokerage and risk-management services firm Arthur J. Gallagher AJG posted good first-quarter results in light of continuing weakness in insurance premium rates and a modest but developing recovery in demand. Internal brokerage revenue (excluding contingent commissions and acquisitions) declined 3% from the first quarter of 2009, a somewhat better result than recent quarters and despite a roughly 5% decline in premium rates that Gallagher estimated for its relevant markets. Client exposure units were flat in the first quarter, after declining over the past two years. Gallagher's profitability in its brokerage operations has been improving over the past year, despite marked market weakness, and its EBITDAC margin continued to rise slowly in the first quarter of 2010 on a seasonally adjusted basis. Gallagher believes its brokerage results have been lagging a recovery in economic activity, as they should, and its leaders are reporting better prospects in acquisitions as well as new business production.

News comes today that the largest publicly traded insurance brokerage organizations--Marsh & McLennan Companies MMC, Aon AON, and Willis Group WSH--have reached "restated agreements" with various state regulatory authorities allowing them to take contingent commissions, a practice that had been banned since 2005. This news follows on the heels of Arthur J. Gallagher's AJG 2009 agreement winning over Illinois authorities to that position. We've been expecting some rationalization of regulatory practice along these lines.

Arthur J. Gallagher's focus on selling insurance to niche market clients and successful development of scale and scope economies garner the firm a narrow economic moat.

Insurance brokerage and risk management services provider Arthur J. Gallagher AJG reported improved revenue and profitability in the fourth quarter of 2009. Organic revenue in brokerage was off 1.1% on a year-over-year basis, a good result in light of the 5.5% year-over-year decline in the third quarter of 2009, and significant further declines in insurance premium rates through the end of 2009. On a sequential basis, organic brokerage revenue (excluding acquisitions and other special effects) rose from the third quarter to the fourth quarter, in contrast to the decline in 2008.

Arthur J. Gallagher AJG reported modestly weaker third-quarter results than we had anticipated, but the overall picture is one of continued improvement from 2008, and we will keep our fair value estimate. Total revenue rose 3% from a year ago, and revenue growth slowed from the second quarter after discounting normal seasonal trends. Lower investment income arising from low interest rates played a material role in the revenue weakness, but we would have liked to have seen better results on the commissions and fees lines. Internal (excluding acquisitions and other items) commission and fee revenue declined 5.5%, as insurance rates and overall demand for insurance remained pretty weak. But we were encouraged by the earnings acceleration in Gallagher's risk-management segment, driven as it is by client payroll head counts. Pretax income from continuing operations rose significantly from a weak year-earlier result but was basically flat on a sequential basis.

Arthur J. Gallagher's focus on selling insurance to niche-market clients and its successful development of scale and scope economies garner the firm a narrow economic moat.

Insurance broker Arthur J. Gallagher AJG reported second-quarter earnings that were generally in line with our expectations, and we will keep our fair value estimate for now. Overall revenue was up 6% year over year in the second quarter as well as the first half; we've been looking for 7% revenue growth for the year, with a stronger second half than the first half, so the 6% growth thus far this year is encouraging in light of still-weak economic conditions and insurance premium rates. Operating income grew faster than revenue again in the second quarter. The firm's pretax margin in the brokerage and risk management segments have trended higher this year, on a seasonally adjusted basis, despite the still-soft environment. Gallagher's margins year to date are actually in line with where they were a few years ago, before the recession and the softening in insurance rates.

Arthur J. Gallagher's focus on selling insurance to niche-market clients and its successful development of scale and scope economies garner the firm a narrow economic moat.

When the going gets tough, the tough get going, and that's the bottom line for the first quarter at Arthur J. Gallagher AJG. Management runs a tight ship, and it shows. Cost-savings initiatives and higher productivity around the company led to significant margin improvement despite the impact of the weak economy on Gallagher's insurance production as well as risk management segments. In continuing operations, earnings per share were up 60% over the first quarter of 2008 on a 7% revenue increase.

Insurance intermediary Arthur J. Gallagher AJG posted a strong earnings result in its first quarter, on first impression. Internal revenue (excluding acquisitions and contingent commissions) was basically flat, as it was for 2008 as a whole, with Gallagher citing a continued weak pricing and economic environment. Cost-saving efforts led to a significant margin increase in continuing operations, however, where earnings nearly than doubled their year-earlier first-quarter result. At the bottom line, Gallagher reported net income of $26 million, compared with a modest loss in the first quarter of 2008. Late last week, the firm announced its regularly scheduled dividend, and the stock continued to post a dividend yield of about 7% as of Tuesday. We will have a fuller review of the earnings after Wednesday's conference call, but they look very good on the surface, in light of market conditions.

Softening insurance rates and an accelerating economic downturn led insurance brokerage firm Arthur J. Gallagher AJG to post weak fourth-quarter results Tuesday. Gallagher's mix of service offerings includes a relatively large share of payroll-based businesses, which tends to make it more economically sensitive than other publicly traded brokers. Gallagher's internal revenue (excluding acquisitions) declined 4% in the fourth quarter, after a 2% decline in the third quarter.

Arthur J. Gallagher's focus on selling insurance to niche-market clients and its successful development of scale and scope economies garner the firm a narrow economic moat. Our fair value estimate is $33 per share.

Softening insurance markets and a slowing economy continued to weigh on insurance brokerage firm Arthur J. Gallagher AJG in the third quarter. We had reduced our revenue and margin expectations for these factors earlier this year, and we will stand by our fair value estimate. But the negative (2%) internal growth number in the third quarter is a concern. Slowing economic growth hurts Gallagher in one of the strongest areas of its business, the benefits area, where revenue is driven by head counts and claims counts are down.

Arthur J. Gallagher's focus on selling insurance to niche-market clients and its successful development of scale and scope economies garner the firm a narrow economic moat. Our fair value estimate is $33 per share.

Second-quarter earnings at insurance broker Arthur J. Gallagher AJG met our expectations, so we will stick with our fair value estimate. The company continued its acquisitive mode in the first half of the year, adding 20 brokerage agencies, and announced that it is filing to register 10 million additional common shares for future acquisitions. Claims administration revenue continues to be soft, reflecting a weakness in employment and the economy. In the short term, a contracting economy should continue to pressure revenue and earnings growth, but we expect better results after the current cycle reaches bottom.