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Morningstar | Willis Towers Watson Reports a Soft 2Q

While the company remains on track to achieve its cost synergies, Willis Towers Watson’s top-line growth was relatively weak in the second quarter. However, the results didn’t diverge dramatically from our long-term expectations and to some extent appear to be simply a bit of a hangover from a strong first quarter. Long term, we continue to think Willis Towers Watson, like its peers, is capable of producing modest growth and improving margins. We will maintain our $155 fair value estimate and narrow moat rating.

The biggest negative surprise in the quarter was the relatively weak showing of the brokerage business. The corporate risk and broking segment and the investment, risk, and reinsurance segment posted year-over-year growth of only 2% and 1%, respectively, excluding currency effects, acquisitions, and an accounting change. Coming into the year, we expected pricing increases following the flurry of catastrophes in 2017 to be a modest tailwind for the brokers, and Willis Towers Watson’s two largest peers, Aon and Marsh & McLennan, both saw relatively strong brokerage growth in the second quarter. As a result, the company’s poor showing in the quarter stands out. Management noted on the call that the timing of revenue boosted the first quarter and therefore negatively affected the second. Still, even accounting for this, Willis Towers Watson appears to be lagging its peers a bit, and management lowered its cross-selling goals due to lower average size. We’ve always believed the cross-selling benefits from the merger would be modest, and this quarter supports that view.

Results in the human capital and benefits delivery segments were more pleasing, with year-over-year growth of 3% and 9%, respectively, excluding currency effects, acquisitions, and an accounting change. We continue to believe the benefits delivery segment, which contains the healthcare exchange business, is the company’s best near-term growth engine.

While the top-line impacts of the merger appear to be flagging a bit, Willis Towers Watson remains on track for cost synergies. EBITDA margins, adjusted for one-time items and the accounting change, improved to 21.1% from 19.8% last year. Management estimates that it has achieved about $150 million in annual run-rate synergies, and is targeting $175 million by the end of the year, which is well above the company’s initial estimates. While management may have oversold the cross-selling benefits of the merger, we believe the cost synergies provide a sufficient rationale.