Aon PLC

After reassessing our assumptions, we are changing our Morningstar Capital Allocation Rating for Aon to Standard from Exemplary.

Why it matters: CEO Greg Case has held his position since 2005. Over his long tenure, Aon has seen dramatic change. Under his watch, the company’s business has shifted from an insurance-focused organization into a provider of a wider set of risk management tools. However, the failure to complete the Willis Towers Watson deal in 2021 suggested that transformative acquisitions are now off the table, due primarily to antitrust limitations. We believe Case deserves credit for reorienting Aon's business in a manner that did not dilute the moat surrounding its core legacy operations. We are also impressed with management's ability to improve margins over time.

The bottom line: After reviewing the company's situation, we think a Standard rating is more appropriate for the narrow-moat company, as we believe the potential for Case to create value through M&A will be much more limited going forward. We will maintain our $341 per share fair value estimate. Aon has shifted course and has made moves to acquire middle-market insurance brokers NFP and USI in recent years for $13 billion and $17 billion, respectively. Both of these moves were sizable and made basic strategic sense, in our view. However, we don't think either deal will prove value-creative at the prices that Aon paid or will materially alter the company's long-term path in terms of growth or profitability. We would not be surprised to see Case complete more deals like this in the future, as his history suggests he is unlikely to stand still, but we think a more skeptical view on the value of future M&A is warranted at this point. We believe a greater focus on capital returns would be in shareholders' best interest going forward.

Our fair value estimate for Aon is $341 per share, or 18.0 times 2026 earnings (excluding amortization and one-time expenses).

Aon has been enjoying tailwinds and strong top-line growth recently due to higher insurance market pricing, a bounceback in more discretionary services, and higher interest rates. However, these tailwinds have started to fade. We expect results to normalize and for the company to generate mid-single-digit top-line organic growth. Further, we think a weak insurance pricing market is likely to be a headwind for the company in the coming years. The result of our projections is a 4% organic compound annual growth rate over the next five years. We expect organic revenue growth to be roughly equally weighted between Aon's brokerage and human resources segments over the long term, though the human resources segment is more exposed to near-term macroeconomic headwinds.

We expect operating margins (adjusted to exclude amortization and one-time expenses) to improve from 32% in 2025 to 34% by 2030, improving about 30 basis points annually on average over the projection period. Lower short-term interest rates and the inclusion of USI could modestly pressure margins in the near term, but we expect cost reductions over time to more than offset this. In the longer term, we see only modest potential for further margin improvement given the company's flexible cost structure.

We use a cost of equity of 7.7% and a weighted-average cost of capital of 7.1% in our valuation.

Aon's relatively sticky client base and its global presence are the main sources for its narrow economic moat.

Aon’s insurance brokerage operations represent about two-thirds of revenue and are therefore the primary driver of our narrow moat rating. Aon acts as an advisor and insurance and reinsurance broker, helping clients to manage their risk by negotiating and placing their insurance risks with insurance carriers through its global distribution network.

Insurance brokers such as Aon are uniquely positioned to serve a necessary risk management function. Brokers can help clients understand their insurance needs. They then can search the insurance market more efficiently and effectively than individual buyers, helping clients to compare insurers' skills, financial strengths, and reputation. During the matching process, brokers also help insurers solve problems related to asymmetric information, such as adverse selection and moral hazard.

The complexity of these services creates switching costs, as we believe the value of changing providers is not clear to customers and there is perceived value for the client in continuing to work with a broker that has experience in managing their risk. As a result, Aon’s client retention rates are typically over 90%.

While about 80% of clients are middle-market companies, Aon’s global presence limits potential competition at the top end of the corporate market as it allows the company to effectively serve multinational customers that smaller brokers cannot. Additionally, the scale and breadth of its operations allows the company to build out a wider set of data and experience, which we believe improves the value of its services even at the middle-market level.

Aon's consulting businesses are more diffuse and operate in several markets with differing levels of competition. Operating margins, excluding purchase amortization expenses and one-time charges, have been lower than on the brokerage side historically, suggesting this side of the business is not as advantaged as brokerage operations but still benefits from relatively sticky customer relationships.

Ultimately, we see Aon as a relatively stable business that benefits from minimal capital requirements and enduring relationships. Returns on invested capital excluding goodwill are multiples above any reasonable estimate of the cost of capital.

The tollbooth nature of its brokerage operations makes Aon a relatively stable producer of free cash flow.

Aon’s established corporate relationships provide an opportunity to enter and cross-sell new services and move into a larger risk-management role over time.

The global brokerage industry remains fairly fragmented, leaving plenty of space to expand without intense head-to-head competition.

Aon's established position in relatively mature markets lowers its long-term growth prospects.

Aon has historically shown a willingness to expand into new areas, and this could dilute its moat.

Aon has aggressively repurchased stock in recent years, implying that management sees little opportunity for value-creative reinvestment.