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Truist provides positive read-through for the broker space

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On Thursday last week, Truist Insurance provided its traditional first look at trends in the insurance broking sector. The report largely echoed the creeping sense of optimism that AJ Gallagher shared on its investor day in December.

Although Truist’s sizable exposure to middle-market/wholesale makes it less comparable to other public brokers, it can serve as a directional proxy for the industry.

Truist insurance reported organic growth of 2.9% (4.9% excluding merger impacts). It also disclosed 390bps of Ebitdac margin expansion and the touted pricing environment with a particular emphasis on the E&S space. The broker saw a substantial growth in new business volume at 19.5%, following the reversal in Q3 to 8.4% expansion from 4% contraction in Q2.

It boosted its M&A activity in the quarter, in line with the earlier reports from investment bankers that deal making in the sector accelerated towards year-end. In the quarter, Truist Insurance performed five acquisitions for a combined annual revenue of $110mn representing around 5% contribution to the broker’s existing revenue base.

Notably, both Truist’s insurance and banking executives sounded incrementally more bullish on the economy.

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Taking a step back, if Truist’s macro optimism becomes the reality, brokers may find tfhemselves in a highly favorable setting in the second half of 2021.

With the pricing environment widely believed to persist through at least the end of 2021, a buoyant economic recovery associated with exposure growth and growing demand for brokers’ more cyclical and HR-related products (e.g. consulting, risk management, benefits) may turbocharge growth, which makes us constructive on the industry for the year.

Should this scenario play out, broker stocks may have a strong year (relative to the market), particularly given low interest rates are likely to keep pressuring valuations in more interest rate-sensitive parts of financial services as the Fed seems committed to keeping rates low along the entire yield curve for some time during this expansion cycle.

However, we’d note that recently performances in the industry significantly diverged despite the high historical synchronicity. This is likely due to the announcements from Aon and Marsh & McLennan on relaxing expense controls, while AJ Gallagher continued reassuring investors on the recurring nature of the cost savings. This may have resulted in a substantial amount of optimism being priced in Gallagher’s EPS estimates, as well as the stock's outperformance over recent months.

Meanwhile, the shares of the Big Three brokers are entering the Q4 earnings season having remained mostly flat since July last year.

Should the brisk economic recovery forecast materialize, the Big Three brokers with sizable exposures on cyclical revenues may see a catch-up rally as attention shifts from expense actions to the improving macro environment and growth acceleration.

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Now, the economy has likely never been this hard to forecast, as there are still many uncertainties around the speed of mass vaccination, vaccine supplies and the post-pandemic structural changes to the economy. However, there seems to be a growing sense of macro optimism among brokers and other finance executives, which is a positive sign for an industry where organic growth has been considered the main driver of profitability.

Recall that earlier, many banking executives – including Bank of America, Citigroup and Goldman Sachs – speaking on the earnings calls, shared incremental optimism about the pace of the economic recovery in 2021.

Of course, for Aon and Willis the valuations will also remain a function of the merger and the resulting cost and revenue synergies/dis-synergies should the transaction close in H1:21 as scheduled.

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