We are downgrading our recommendation on Willis Group Holdings plc ( WSH ) to Underperform from Neutral due to the headwind from The Loan Protector business that is expected to weigh on its North American results.
The Loan Protector business acquired through the Hilb Rogal and Hobbs purchase has experienced a revenue dip. The decline was largely due to client loss through attrition and merger and acquisition activity, tightened commission and drag in foreclosure.
The company, therefore, expects weak performance at the Loan Protector business to adversely affect the North American segment's earnings before income tax by $27 million to $30 million for the full year 2011. North American segment suffered a revenue decline of 5% in the third quarter. Management also estimates contribution from The Loan Protector business to fall to $10-$14 million of pretax operating income annually from $40 million in 2010.
Also, total expense of Willis has been increasing every year. In the third quarter, total expense increased 7% year over year largely due to an increase in salaries and benefits, driven by an increase in amortization of cash retention awards. Willis expects salary and benefits expense to increase by $100 million in 2011.
Also, the company expects depreciation expense to be approximately $17 million in the fourth quarter, and amortization of intangible assets expense for full year 2011 to be approximately $69 million and interest expense to be approximately $34 million in fourth quarter.
Willis has also been experiencing a decline in investment income over the past few years, a trend that continued through 2010, due to lower average interest rates.
Counting on the positives, organic growth in commissions and fees, which forms the major component of Willis' revenue, has exceeded its peers on an average. In the third quarter, it grew 4%, driven by strong new business growth, partially offset by declining premium rates and other adverse market factors. With solid retention levels and new business growth, we expect the company to increase revenues.
In order to reduce operating expenses, during 2008, Willis undertook a cost saving initiative. Year to date, the company realized cost savings of $48 million, of which $24 million was realized in the third quarter. Willis expects cost savings of approximately $75 million in 2011, reaching annualized savings of approximately $115 million to $125 million beginning in 2012.
Willis Group's third quarter earnings were ahead of the Zacks Consensus Estimate as well as the year ago earnings, driven primarily by higher commissions and fees. The expense-saving and efficiency-enhancing initiatives also contributed to growth.
The Zacks Consensus Estimate for fourth-quarter 2011 is 48 cents per share. For full years 2011 and 2012, the Zacks Consensus Estimates are, respectively, $2.77 per share and $3.06 per share.
The quantitative Zacks #5 Rank (short-term Strong Sell rating) for the company indicates downward pressure on the stock over the near term.
Headquartered in London, United Kingdom, Willis Group Holdings plc and its subsidiaries provide a broad range of insurance brokerage, reinsurance and risk management consulting services to its worldwide clients, both directly and through its associates. Its major competitors are Arthur J Gallagher & Co. ( AJG ), Aon Corporation ( AON ) and Marsh & McLennan Companies Inc. ( MMC ).