Towers Watson Announces Mixed Results

After historically beating expectations most quarters, for the second consecutive quarter, Towers Watson announced mixed results this morning. The headline will show EPS upside ($1.59, versus our estimate and consensus of $1.48) and EPS guidance for the year increased slightly ($5.65-$5.70 now, versus $5.55-$5.65 previously). The upside in the quarter mainly came from a lower-than-expected tax rate, though, as well as slightly better-than-expected profit margins (helped by lower bonus accruals). Revenue of $905 million was $13 million (1%) below the consensus and reflected a 1% decline in revenue for the consulting businesses (i.e., excluding the exchange solutions segment, which does not capture the impact of the active employee exchange).

We expect to get more color on the conference call at 8 a.m. Central time, but the commentary in the press release suggests that the biggest issue continues to be choppy demand trends in Europe (according to the press release, revenue in the Americas was in line with management’s expectations). The weakness in the consulting businesses will not surprise investors as much as it did last quarter and the business was not as weak as last quarter, but we also believe there was a growing sentiment among investors that the company had moved past the worst of its challenges for the consulting business.

Therefore, these results will be a little disappointing. We still believe, though, that demand in Europe will start to improve and some changes in the pension industry could drive additional lump sum and project work later this calendar year, so we remain optimistic that the performance of the consulting business will improve. As it relates to the healthcare exchange, there was limited commentary in the press release other than the fact that the retiree exchange is seeing encouraging off-cycle enrollments (there have been some media articles in the last month about Northrup Grumman [NOC $120.95] switching to Towers Watson’s retiree exchange in an offcycle enrollment process) and management remains “very pleased” with its acquisition of Liazon. Similar to Aon (AON $85.15; Outperform) and Mercer, we do not expect many explicit comments about expected enrollments for the company’s active exchange for next fall, but we hope to get a little more color about the demand environment for the exchange business on the conference call. Shares of Towers Watson trade at 20 times our next 12 months’ EPS estimate, which compares with an average of around 17 times that we see for most consulting firms that we cover.

The continued choppiness in the consulting business is disappointing, but we view the challenges for that business as being mostly temporary and we remain optimistic about the long-term growth of the company’s exchange business. Our rating thus remains Outperform. We would be particularly aggressive buying the stock on any pullbacks toward $100, at which point the multiple would be basically in line with the average consulting company that we track.