Brown & Brown: A Compelling Investment Opportunity (NYSE:BRO)

Investment Thesis

Despite Brown & Brown, Inc.’s (NYSE:BRO) solid share growth of more than 16% in the previous year and more than 345% in the last decade, the company appears to be selling below its fair value, providing a good investment opportunity. I attribute this outstanding success to the company’s robust growth levers, which include strategic acquisitions and an excellent business model.

While this past performance could be a compelling reason for some investors to cash in here, I believe blending this with future projections would make a good investment case. With this background, I am bullish on this stock in the long run due to its solid growth levers and market potential. Looking at some of the company’s current affairs, such as the investor day expected today (14^th September 2023), my optimism on the stock is further solidified.

Further, BRO has delivered to its shareholders something very enticing to me. Specifically, the company has a total return of about 400% over the last decade compared to the S&P 500 total return of nearly 300%. Further, with a dividend per share growth of more than 200%, it has surpassed the industry median by about 100% in the same time frame, exhibiting the company’s commitment to its shareholders. Given my bullish stance on the company and the pleasant return to investors, I confidently rate this company a buy.

Current Affairs And My Take On Them

I have been following BRO’s news closely recently, and several of them have drawn my optimism on this stock, some of which I will discuss here and give my opinion. To begin with, is the company’s Investor Day to be held today (14^th September 2023). Based on my experience with companies’ investor days, this event will provide an overview of the company’s business strategy, financial performance, growth potential, and capital allocation priorities. Furthermore, the corporation’s long-term financial targets will be revised. As a result, this event, in my opinion, will benefit the company’s success because it may boost transparency and credibility and appeal to investors and analysts. For example, an upward revision in financial targets may fuel share price growth.

Another current affair that has drawn my attention and fueled my optimism is the company’s Q2 2023 results. The company’s total revenues for the quarter were a record $1.047 billion, up 24.7% year over year. It also posted a record $1.068 billion in core operating income, an increase of 23.4% year over year. The combined ratio for the corporation in the second quarter of 2023 was 88.9%, down from 90.6% at the same time the previous year, an indicator that the company’s financial results are improving. I believe these results demonstrate its resilience, efficiency, and quality in its core insurance business, which bodes well for the company’s future performance.

Lastly, my focus on current affairs is the acquisition of New England Excess Exchange (NEEE). NEEE is a managing general agent that offers excess and surplus lines insurance products and services to New England independent agents. I expect this acquisition to fuel the BROW’s growth and performance due to a number of synergies. Below are some of the synergies I expect and how I expect them to be realized.

Revenues Synergy: The acquisition will help the company expand its offerings and visibility in the lucrative excess and surplus lines insurance market. The organization can capitalize on its connections with carriers and retail agents to reach a wider variety of customers through cross-selling.

Strategic Synergy: The acquisition will be consistent with the company’s strategy of acquiring and merging complementary firms that will allow it to extend its global reach, product offerings, client groups, and specialized markets. In addition, the acquisition will boost the company’s competitive edge and distinction in the insurance business. The competitive edge will arise from the diversified global reach and entering new market segments.

Cost synergy: The acquisition will provide the company with operational efficiencies and economies of scale by allowing it to streamline its processes, systems, and resources. By exchanging best practices, experience, and technology with New England Excess Exchange, the company will be able to lower its expenses and risks.

In general, the company’s current affairs are nothing short of optimistic. Judging from the information above, this company has a bright outlook.

Growth Levers: The Core Of Future Success

To expand, a firm must rely on solid growth levers that are both sustainable and long-term in nature. With this background in mind, BRO is in an excellent position to foster long-term success through its long-term growth levers.

First, the company’s diversified and resilient business model allows it to operate successfully in various market conditions and customer segments. Its model is based on four segments;

Retail: This section offers a variety of insurance products and services to businesses, public and quasi-public institutions, professionals, and individuals. The segment supports construction, healthcare, transportation, hospitality, manufacturing, and technology. This division makes money from commissions, fees, and profit-sharing.

National Programs: This segment tailors insurance products and services to niche markets that need underwriting, claims, or risk management expertise. Over 50 programs target professional liability, workers’ compensation, flood insurance, social services, public institutions, and agricultural insurance customers.

Wholesale brokerage: This segment offers excess and surplus lines insurance for difficult-to-place or complex risks not covered by ordinary insurers. The section services energy, marine, aviation, environmental, cyber, and property industries from over 40 US and Bermuda offices.

Services: This division offers value-added services to supplement the company’s insurance products. The section has around 20 service firms that offer third-party administration, claims management, risk management consulting, managed care programs, Medicare set-aside services, and reinsurance intermediary services.

Below is the revenue distribution between the four segments;

The model is resilient because it has withstood numerous tests, from Covid 19 through the current inflationary setting. The company’s strong financial results are evidence of this. For example, in the last five years, its annual revenue has increased from $2.01B to $3.57B by 2022, a growth of 77.6%.

I believe this model will be essential to the continued growth of the organization in several key areas, including;

• Maximizing booming economies to mitigate the effects of poorly performing economies. Also, the diverse revenue streams (segments) will help the company to cope in the event one stream faces adversity because the other three can sustain the company.
• Gain access to and serve a broad and diverse consumer base from various regions, markets, and industries. This translates to diverse revenue streams.
• Benefit from its global network of offices, agents, brokers, and partners to provide high-quality products and services tailored to local customers. This would increase customer satisfaction, translating to improved loyalty.

Strategic acquisition is another growth lever that I feel will benefit the organization. BRO has a successful track record of acquiring and merging complementary businesses that can help it extend its geographic reach, product offerings, customer bases, and specialized markets. Since 1993, the corporation has executed approximately 500 acquisitions, contributing over $1 billion in annually revenue. With this track record, it is reasonable to be optimistic about future acquisitions like the NEEE deal, which is next in line.

With these two key growth drivers in place, I believe BRO can weather any economic storm and enjoy sustained strong financial performance. The company’s successful strategic acquisitions and resilient and diverse business model lend credence to my assertions.

Market Potential: A Positive Outlook

Given the increasing sector and the company’s great business model and strategic acquisition, I am excited to explore the market potential for BRO. Between 2023 and 2032, the insurance brokerage industry is expected to increase at a CAGR of 9.3%. The market is expected to grow to $628 billion by 2032, up from $259.7 billion in 2022. The market’s expansion is dependent on various variables, including rising demand for insurance policies, the application of distinct valuation methodologies, and the global increase in HNWIs.

This expansion has prompted me to assess the company’s potential in this industry. Using data from 2018–2022, I estimated the extent to which the company’s revenues have responded to the expanding market by conducting correlation and covariance analyses. Below is the output of the analysis.

According to the output, the company’s revenue has a strong positive correlation and covariance with the market, which gives me confidence in the company’s future revenues in the light of the projected market growth, hence the company has a very high potential in this growing industry.

Valuation

Although the relative valuation metrics are above the industry medians, leading us to conclude that BRO is trading at a premium, this pricing is justified because the company is way above the peer medians on nearly all fronts, ranging from growth, earnings revisions, profitability, and momentum.

To establish the company’s fair value, I will use a DCF model because this method accounts for the project’s cash flows, not the accounting profits. In my model, I assumed a growth rate of 10%, slightly above the historical average growth rate of 9.4% from 2016 to 2022, and a terminal growth rate of 3%, slightly lower than the US’s 3.67% last five inflation rates.

For the discount rate, I used the company’s WACC, which I arrived at using the formula WACC = E / (E + D) * Re + D / (E + D) * Rd * (1 – T), where;

E=market value of equity

D=market value of debt

Re=cost of equity

Rd=cost of debt

T=effective tax rate

Below is the WACC based on this formula.

Using this WACC as the discount rate and the other assumptions given above, below is my DCF output model.

According to my model output, the company has a fair value of $96, implying a 32% upside potential. These results indicate a bullish trend, which I believe will be supported by the company’s strong growth levers. These findings suggest that the stock is trading at a discount to its intrinsic value and has room to grow by double digits, making it an attractive investment.

Risks

Although investing in BRO has the potential to be a successful and rewarding experience, there are risks to be aware of and prepared to confront. Among the potential risks are:

Acquisition risk: Acquisition and integration of complementary firms to extend geographic presence, product offerings, consumer segments, and specialized markets are key to the company’s growth strategy. Acquisition risks include overpaying, failing to achieve synergies, cultural or operational difficulties, and regulatory or legal issues. Technology, client preferences, and market saturation may boost competition or decrease demand for the company’s acquired firms. These variables could hurt the company’s finances and ROI.

Integration risk: Four segments and over 300 profit centers make up the company’s complex and dispersed structure. The organization serves more than 60 nations and territories with distinct laws, rules, cultures, and client expectations. The organization may fail to integrate its companies and activities, resulting in operational inefficiencies, cost duplication, crucial personnel loss, or consumer dissatisfaction.

What Is The Opportunity Here?

Based on this analysis, I believe BRO is a great investment opportunity due to its double-digit upside potential supported by robust growth levers. Furthermore, the outstanding dividend growth and total returns demonstrate the company’s commitment to creating wealth for its shareholders. Given this context, I am confident in recommending this stock to potential investors looking to diversify their insurance broker market portfolios.