Company Reports

Hard-hit insurance broker Brown & Brown BRO reported improved revenue trends and stabilizing pretax margins in the second quarter, an encouraging sign in light of the marked weakness in Florida and Southeast U.S. economies, where Brown draws a relatively high share of its overall volume. Total commission and fee revenue declined 1% from the first quarter of 2010 and 4% from the second quarter of 2009, but revenue looks to have improved in comparison with the trend in recent quarters. Brown's trailing-four-quarter commission and fee revenue total flattened out from the first quarter, after significant weakness in the previous six months, and the decline in this revenue from the first quarter to the second quarter was the smallest in the past four years.

Brown & Brown's unique sales and service-oriented growth culture couples with favorable insurance intermediary economics to yield the brokerage firm a narrow moat. Brown has delivered superior returns to shareholders, historically, and has developed a motivated network of professionals sharing common values and pooled insurance buying power. But the firm has faced significant challenges from the weak Southeast economy, softening insurance rates, and declining investment yields in recent years.

Insurance broker Brown & Brown BRO reported that internal revenue continued to decline on a year-over-year basis in the first quarter, consistent with marked continuing weakness in the Southeast economy, particularly in Florida, where Brown generates nearly one third of its total revenue. In addition, property and other insurance rates in Florida continued to decline significantly, and the firm cited still-weak economic conditions for its small to middle-market customer base generally around the country. We recently reduced our 2010 revenue growth assumptions for Brown in light of other evidence of continuing weakness in the Southeast as well as for smaller businesses, and we will retain our revenue projections and fair value estimate for now.

Brown & Brown's unique sales and service-oriented growth culture couples with favorable insurance intermediary economics to yield the brokerage firm a narrow moat. Brown has delivered superior returns to shareholders, historically, and has developed a motivated network of professionals sharing common values and pooled insurance buying power. But the firm has faced significant challenges from the weak Southeast economy, softening insurance rates, and declining investment yields in recent years.

Brown & Brown's unique sales and service-oriented growth culture couples with favorable insurance intermediary economics to yield the brokerage firm a narrow moat. Brown has delivered superior returns to shareholders historically and has developed a motivated network of professionals sharing common values and pooled insurance buying power. But the firm has faced significant challenges from the weak Southeast economy, softening insurance rates, and declining investment yields in recent years.

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.

Insurance broker Brown & Brown BRO reported a significantly weaker top line as well as further margin contraction in the fourth quarter of 2009. Internal revenue (excluding contingent commissions and acquisition effects) declined 8% from a weak fourth quarter of 2008. Brown's year-over-year internal revenue comparisons have been getting worse in the past few quarters amid relative stability or modest improvement among its peers. The firm's pretax margin came in at 19%, well below the year-earlier 23% quarterly result, and the trend toward lower reported profitability accelerated as the pretax margin for 2009 came in at 26% compared with 28% in 2008. Weakness in the Florida and Southeast economies have certainly been partially responsible, but Brown's special programs and Western retail segments also reported larger internal revenue declines in the fourth quarter than the companywide total. Our fair value estimate is unchanged pending a review of the firm's 10-K filing.

Brown & Brown's unique sales and service-oriented growth culture couples with favorable insurance intermediary economics to yield the brokerage firm a narrow moat. Brown has delivered superior returns to shareholders historically and has developed a motivated network of professionals sharing common values and pooled insurance buying power.

Insurance brokerage Brown & Brown BRO reported persistent further weakness in internal revenue in the third quarter. Overall revenue fell 1% from the year-ago quarter, while internal revenue (excluding acquisitions) fell 5%. The internal growth result was a modestly larger decline than the average for the previous four quarters and certainly below our longer-term expectations for the historically rapidly growing firm. We think Brown has performed well in managing expenses this year; its pretax margin has stabilized and even improved modestly in recent quarters on a sequential basis, after discounting normal seasonal trends. Economic weakness, particularly in Florida and the Southeast United States, certainly plays an important role in Brown's growth results, but we are looking for better results in the fourth quarter. Internal growth as well as acquisition progress bear watching. Our fair value estimate is unchanged.

Insurance brokerage Brown & Brown BRO reported further significant weakness in internal revenue in its second-quarter results, released Monday. Internal revenue (excluding acquisition effects) fell 5% in the second quarter, in line with the firm's performance in 2008 and into the first quarter of 2009. Brown has lagged its insurance brokerage peers in this measure since 2007, in part because of the marked severity of the economic downturn in Florida, where the firm has a significant presence. Brown's pretax margins have been trending down in the past few years, but appear to have stabilized in the latest quarter on a sequential basis, at a still-high 27%. We assume a 3% decline in internal revenue for 2009 as a whole. Our fair value estimate is unchanged.

Brown & Brown BRO reported first-quarter results Monday that were in line with our expectations, and we will keep our fair value estimate unchanged. Internal revenue--which backs out revenue from acquisitions--continued to decline in the first quarter at a rate of 2.2%, a sign of the difficult market factors facing the company. The Florida and Western retail segments were the weakest, as these regions have been hardest hit by the recession. Brown derives a significant portion of its revenue from these areas, especially Florida.

We have lowered our moat rating on Brown & Brown BRO, and as a consequence we have lowered our fair value estimate slightly. Although we continue to believe Brown has a strong business capable of generating returns in excess of its cost of capital, we've concluded that the firm's competitive advantages have weakened somewhat. Historically, Brown has led its peers in terms of organic growth, a sign that it was able to consistently provide differentiated service for its clients. More recently, the tides seem to be turning as Brown has been lagging its peers on this score. Furthermore, though we like Brown's operating structure and motivating culture, we don't feel this factor makes for as strong a competitive advantage as in the past.

Historically, insurance broker Brown & Brown has been able to deliver superior returns to shareholders and distinguish itself from competitors through its decentralized, motivated network of professionals. We do not expect its future performance to keep pace with results in the last decade, but we still believe this narrow-moat firm can deliver above-average returns.

Brown & Brown's BRO fourth-quarter results came in a little weaker than we expected, but we don't anticipate changing our fair value estimate. Internal revenues declined 4.7% in the quarter. Although this number is in line with our expectations for Brown, we have recently become slightly more optimistic given stronger internal growth at other insurance brokers. In the fourth quarter operating margins declined to 24.9% compared with 26.2% during the same period a year ago. Full-year 2008 operating margins were 29.4%. While these results were slightly worse than our forecast, and the firm's internal growth bears watching closely, Brown's margins remain the highest of the insurance brokers we cover.

Historically, insurance broker Brown & Brown has been able to deliver superior returns to shareholders and distinguish itself from competitors through its decentralized, motivated network of professionals. We do not expect its future performance to keep pace with results in the last decade, but we still believe this wide-moat firm can deliver above-average returns.

We are placing Brown & Brown BRO under review while we transfer coverage to a new analyst.

Brown & Brown BRO reported a modest year-over-year decline in earnings per share on Oct. 20, but the results were in line with or somewhat better than we expected. Total revenue was up 9% in the quarter. With the effects of acquisitions backed out, internal revenue continued to contract, albeit at a slower pace than earlier in the year. Management attributes internal revenue contraction largely to the soft insurance market, along with continued margin compression.