Insuring Greatness
The Berkshire Hathaway of Insurance.
That’s what we call our next buy.
Just like Berkshire Hathaway and Constellation Software, they use a decentralized business model and benefit from a great company culture.
Insuring Greatness
Our Next Buy is the fifth-largest independent insurance brokerage in the United States. The company serves as a middleman connecting insurance providers offering insurance products and services with customers seeking insurance coverage. The majority of their insurance offerings fall into the categories of property and casualty, employee benefits, and personal insurance. The company markets and sells insurance products and generates more than 90% of its revenues in the United States. They have more than 80 years of experience in offering insurance products and services to businesses, corporations, governmental institutions, professional organizations, trade associations, families, and individuals.
Most of its revenue is generated via commissions (around 70%). Brokers earn a commission for each successful sale of insurance, typically in the range of 10%-15% of the annual premium. Most fees are paid by insurance companies, but a smaller percentage is also paid directly by customers. The company states that their growth is impacted for 25%-35% by changes in premium rates and 65%-75% by changes in exposure units. The business is active in four segments: Retail (58% of sales), National Programs (24% of sales), Wholesale Brokerage (13% of sales) and Services (5% of sales).
The ‘Berkshire of Insurance’ is a family company with a strong culture. In total, insiders own 16.6% of the business. Furthermore, their employees own another 5-6%. The company is still run by the grandson of the founder. Each person within key management has been working for the company for a very long time and has skin in the game. Around 60% of employees of the company own shares.
The company has a competitive advantage based on its decentralized business model, performance-based culture, skin in the game, and great capital allocation skills. It’s a serial acquirer just like Constellation Software. The acquired company typically retains its branding. Each branch is accountable for its profit and loss, and most expenses are assigned at the operational level. The company has disclosed that its corporate overhead constitutes only 5.5% of revenue, a significantly lower figure compared to the industry's typical range of 9% to 18%. Another key competitive edge the company enjoys is its focus on the middle market, which consists of businesses employing 20 to 1000 individuals. This strategic choice means dealing with fewer large clients and facing less competition from bigger brokerage firms. This aligns perfectly with the company's decentralized model and branding.
Over the last 2 decades, there has been a trend of consolidation in the insurance brokerage sector. While the industry remains fragmented, large brokerage firms have consistently acquired smaller peers. In general, the industry’s organic growth is equal to 0-5% in normal market conditions. Over the past decade, the market has grown at a CAGR of 3.0%. It’s great to see that the company we’ll buy performs better than its main peers (lower capital intensity and higher growth and profitability).
The capital intensity is low. Last year, the company’s CAPEX/Sales and CAPEX/Operating Cash Flow were equal to 1.5% and 6.4%. The company’s capital allocation policy is based on having low leverage, industry-leading margins, high cash flow conversion, and investment-grade ratings. On average, they spend 90% (!) of its cash flow on acquisitions. The company is also a dividend aristocrat as they increased their dividend for 30 (!) consecutive years. The company’s dividend yield and payout ratio are currently equal to 0.7% and 17.8%. Over the past 5 years, the company’s ROIC, ROE, and Return on Tangible Assets averaged 7.9%, 13.7% and 19.1% respectively. The business operates at a Gross Margin and FCF Margin of 49.1% and 23.2% respectively.
Since 1993, they have grown their revenue from $95.6 million to $3.6 billion in 2022. This means their revenues compounded at 13.3%. Over the same period (1993-2022), the company increased its net income from $8.1 million to $671.8 million in 2022, a 16.5% compound annual growth rate. These numbers look very attractive to us. The consensus estimates that they should be able to grow its revenue and EPS at a CAGR of 11.2% and 12.2% over the next 3 years.
Currently, the company trades at a FCF yield of 4.0% (excluding stock-based compensation) and a forward PE of 24.7x. It’s a great example of a wonderful company trading at a fair price. Our Earnings Growth Model estimates that they should be able to return 10.8% to shareholders over the next 10 years. Our Reverse DCF shows that they should grow its FCF per share by 8.1% per year to return 10% per year to shareholders.
As a quality investor, we don’t want to invest in The Next Big Thing. Instead, we want to invest in companies that have already won. Our sixth buy managed to grow its Owner’s Earnings at very attractive rates in the past. The company managed to grow its Owner’s Earnings at a CAGR of 19.5% and 14.5% over the past 5 and 10 years. Since its IPO in 1975, the company compounded at 15.0% per year, significantly outperforming the S&P 500 as well as its peers.
Now let’s tell you which company we are talking about, prepare our transaction for Monday, and share the full investment case of 45 (!) pages with you.