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Where next for dividend paying Direct Line Insurance?

Publication Date: 08 Jul 2019 - By Gaurav S. By Gaurav S.
Actionable
Differentiated

Equity Fundamental Equity EU UK Financial Services

Direct Line Insurance Group (LON:DLG) is a household name in the UK via its ownership of a number of subsidiaries providing various insurance products, including Direct Line and Churchill, and vehicle recovery provider Green Flag.

The FTSE 100 company, formed in 2012 by the divestment of Royal Bank of Scotland Group's (LON:RBS) insurance division through an initial public offering, features prominently among blue chip dividend paying stocks. 

Direct Line's dividend yield currently stands at 3.16%, and the company's 2018 payout marked its seventh successive year of rising dividends, offering shareholders 21p per share. That said, competition is in the sector is getting fiercer by the year courtesy price comparison websites that Direct Line takes pride in avoiding

Looking back at its recent performance, the company with a market capitalisation of £4.75bn, saw an 8% rise in annualised full-year profits for 2018 to £583m. But the jump in profits was in part due to a drop in finance costs from £103.8m to £19.1m, given it spent over £77m in 2017 to repurchase £250m of subordinated debt.  

Operating expenses for the 12 months to December fell from £806.3m to £722.2m, and the target is to reduce expenses to below £700m. Despite its financials having been boosted by one-offs, many in the analysts’ community are keeping the faith.  

Over the 12-month period to 3 July 2019, ironing out weekly volatility, Direct Line's share price is not substantially higher at 341.70p, rather a mere penny lower having posted a 52-week high of 366.50p versus a low of 300.66p. 

According to rating agency Moody’s, the company looks set to maintain its strong profitability by continuing to prioritise target loss ratios over premium volumes in a “competitive market and despite a change in its profit drivers.”

The bulk of Direct Line's profit comes from the very competitive and highly regulated UK personal motor market, where claims inflation is increasing and there is uncertainty around the outcome of a regulatory review of pricing practices.

"But we expect Direct Line to counter headwinds in the motor and home markets by continuing to prioritise target loss ratios over premium volumes. Profitability could get a further boost from an ongoing programme to upgrade its major IT systems," Moody’s noted. 

Conclusion: In 2018, Direct Line's return on capital improved to about 13% from an average of 12% over the 2014-2018 period helped by the group's second-highest after-tax profit in the last 10 years. Direct Line has also consistently exceeded its return on tangible equity target of more than 15%.Alongside a pat on the back from Moody’s, is a Refinitiv Eikon survey of brokerages covering Direct Line's stock, with 7 rating it as a "buy" or higher, 7 as "hold" and 3 as "sell" or lower, with a median price target of 360p. 

Some such as RBC Capital Markets have price targets as high as 395p. Such levels in the current state of the UK insurance market might be a bit too optimistic and the 355p to 365p range might be more realistic. Given Direct Line is a dividend paying stock attempting tighter cost controls, perhaps holding position for the next 12 months to see how things unfold might be the best course of action. 

Disclosure:

I have no positions in any of the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

I agree with the terms and conditions of ReachX

This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

Gaurav S.

 

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