Thursday, November 26, 2009

Brown and Brown - Stock Analysis for Dividend Growth Portfolio

Brown & Brown, Inc. (BRO) and its subsidiaries, provides insurance and reinsurance products and services, as well as risk management, employee benefit administration and managed health care services. It is a diversified insurance agency and brokerage firm, markets and sells to its customer’s insurance products and services, primarily in the property and casualty area. BRO has operations in 219 locations and in 37 states.

BRO is member of Mergent’s Dividend Achiever Index and S&P Mid-Cap 400 Index. The most recent dividend increase was in October 2009.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

  • Revenue: In general, a growing trend since 2000. The average revenue growth for last 9 years has been approximately 13.8%. Year 2009 revenues are expected to be flat.
  • Cash Flows: Overall, until 2008, a growing trend of free cash flow and operating cash flow. FCF is consistently more than net income.
  • EPS from continuing operation: In general, it had an increasing trend until 2007, drop in 2008, and expected to remain flat in 2009.
  • Dividends per share: Very slow anemic albeit growing trend.


Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.57. This is a low risk category as per my 3-point risk scale. Other than negative EPS growth in 2008, all other parameters are positive.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

  • Dividend growth rate: The average dividend growth of 18.9% (stdev. 4.81%) is more than average EPS growth rate of 12.3% (stdev. 14.5%).
  • Duration of dividend growth: 16 years of consecutive dividends growth.
  • 4 year rolling dividend growth rate for past ten years: More than 10%.
  • Payout factor: It has been less than 30% since 2001.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 1.7%; and (b) MMA yield is 2.9%. With my projected dividend growth of 8.2%, the dividend cash flow is 1.41 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $14.1 (i.e. yield 2.2%)

Fair Value Calculation
This section determines what price I should pay to buy a given stock

  • Net present value (NPV) price based on 15 year DCF: $20.3
  • Average high yield price calculated based on past 10 years: $24.8
  • Pricing based on past 10 year relative price-to-earnings ratio. $29.5
  • Pricing based on price-to-earnings ratio of 12: $15
  • Graham number: $16.4

The range of fair value is calculated as $18.2 to $21.2.

Qualitative Analysis
BRO is a 70 year old company, and is in top 10 independent insurance intermediaries in US. Its growth model consists of growing market share by acquisition of insurance agencies.

  • Its revenue is pretty much focused in US markets; with approx 70% of revenue is concentrated in 9 states.
  • It continues to have very stable gross and operating margins. It continues to generate relatively stable free cash flows.
  • Being in financial service and insurance industry, I am surprised it does not seem to be affect as other major companies. Perhaps demonstrates its resilience and/or quality of its management taking calculated risk.
  • The risk factor is that other than acquisition mode of growth model, there is not other source of growth.

Conclusion
Brown and Brown Inc is stable and slow growth mid-cap company. It is expected to continue to have a sustainable cash flow over next few years. It is typical dividend growth company where dividends grow in excess of 10%. However, the dividends yields are less than 2%. The stock’s current risk-to-dividend rating is 1.57 (low risk). The current pricing of $18 is within my buy range. I would be open to initiating a position based my allocation levels.

Full Disclosure: No position at the time of this writing. I may buy in near future.

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