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Direct Line Group - Dividend rebased, interim jumps 38.8%

Nicholas Hyett | 1 August 2017 | A A A
Direct Line Group - Dividend rebased, interim jumps 38.8%

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Direct Line Insurance Group plc Ordinary

Sell: 270.60 | Buy: 270.80 | Change 1.40 (0.52%)
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First half operating profits of £359.7m represents 13.5% growth on last year, with both in-force policies and gross written premiums increasing. An upward rebasing of the dividend saw the interim payment rise 38.8% to 6.8p per share.

The shares rose 4.9% following the announcement.

Our View

Highly competitive with broadly generic products; few companies can maintain any semblance of pricing power in personal insurance. That tends to drive combined operating ratios (the percentage of premiums that are paid out as claims or expenses) closer to 100% as companies are forced to attract customers through cutting their prices. The advent of price comparison websites hasn't helped.

Fortunately for Direct Line (DLG), the strength of its brands mean it's able to bypass price comparison sites altogether, while also supporting high levels of customer retention. That has helped keep pricing and margins strong. As the market leader, DLG enjoys access to more information on claims and customer behaviour than competitors, helping it to price more accurately, while scale provides opportunities for cost cutting.

The decision to rebase the dividend at the half year is welcome, not only for the immediate cash infusion but because of the confidence it implies in the long term future of the business. Recent results have benefited from bumper reserve releases, but those are unlikely to continue forever and it's the improvements in operating expenses and higher in-force policies that are more important to the group's long term future.

Looking ahead to the full year, investors will be eyeing Direct Line's improved Solvency II ratio with interest. Even after dividend payments, it currently sits at 173%, and with management saying they are looking to operate in the middle of the 140% to 180% range in the normal course of business, there's scope for a healthy special dividend in six months' time. Analysts are forecasting a prospective yield of 6.9% for 2018 - although as ever there are no guarantees where dividends are concerned.

Nonetheless, Direct Line is delivering a respectable underwriting performance in a sector which is currently enjoying a bit of a let up in pricing pressure. If it can maintain its brand position, and resulting price advantage, then the group should continue to generate strong returns.

Half Year Results

Direct Line saw in-force policies increase 0.5% in the first half to 15.8m. Gross written premiums increased 5% to £1.7bn, representing an improving price environment - particularly in Motor following the changes to the Ogden discount rate.

Motor insurance remains by far the largest contributor to group operating profits, at £233.9m, with own brand accounting for the lion's share. Home Insurance delivered profits of £67.5m, ahead of the £30.2m in Commercial and the £22.6m in Rescue and Other Personal lines.

The group's combined operating ratio, a key measure of underwriting performance, improved by 0.7 percentage points to 88.9%. That supported an 11.5% jump in underwriting profit to £172m, while profits from the group's investment portfolio rose 1.8% to £92.6m and other income rose 14.3% to £89.6m.

Direct Line continues to target a combined operating ratio of 93% to 95% for the full year, and has now extended that target into the medium term. The group is targeting a return on tangible equity of 15% over the same period.

The group expects to grow the regular dividend in line with business growth, which it expects to be in the region of 2% to 3% per annum over the medium term.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.