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Direct Line - the return of the dividend

Emilie Stevens, Equity Analyst | 4 August 2020 | A A A
Direct Line - the return of the dividend

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Direct Line Insurance Group plc Ordinary

Sell: 215.40 | Buy: 215.70 | Change 0.20 (0.09%)
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In the first half Direct line's gross written premiums grew 0.4% to £1.6bn, of which £1.1bn were direct own brands. Underwriting profits rose 29.8% to £143.6m, largely thanks to lower claims in Motor and Rescue because of the pandemic, offset by extreme weather and lower reserve releases from prior years. The overall impact of the pandemic has been neutral.

Direct Line has declared an interim dividend of 7.4p per share and special dividend of 14.4p per share to catch up after suspending the payment earlier this year. After these payments the group estimates its Solvency II capital ratio to be 192%.

The shares rose 8.8% in early trading.

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Our view

The impact of coronavirus has been broadly neutral for Direct Line so far as reduced motor claims have offset higher costs and claims elsewhere - such as in travel. The dividend was temporarily suspended, but is now back and the group is paying a special dividend to catch up on what was missed.

In the longer term very little has really changed for Direct Line. Personal insurance remains highly competitive, and with rivals offering pretty generic products, few companies can maintain any semblance of pricing power. That has tended to have negative consequences for combined operating ratios (the percentage of premiums that are paid out as claims or expenses) as companies are forced to cut prices to attract customers. Price comparison websites have only exacerbated the problem.

Nor is that the only headwind. Direct Line is expecting Motor claims to rise at about 3-5% each year, which is putting upwards pressure on prices as insurers raise premiums to compensate.

Against this backdrop, CEO Penny James has firmly focused on cutting costs and leveraging recent investments in technology. COVID-19 may have upset the timing slightly, but we expect the same basic ideas to stick.

Insurers must set aside a portion of the premiums they receive to meet future claims, called reserves. But, if claims turn out to be lower than expected or the rules around how much must be set aside change, the excess can be released as profit. In recent years profits have been flattered by the release of prior years' reserves.

That's unsustainable in the long run, and James wants more profit to come from current year underwriting, driven by lower costs, better underwriting and some growth. That could prove easier said than done though, as better underwriting often means higher prices, which would make growth a challenge.

Direct Line does have a few key advantages. The first is the brand, which has helped it price more aggressively than competitors. The second is scale, because the new, leaner cost base can be spread across more policies. The new technology infrastructure should also help the group compete on price comparison sites, and may improve underwriting accuracy for the direct brands.

Overall we think Direct Line's targets are ambitious but not unachievable - although a lot's riding on the new technology investments living up to their billing. Of course, this relies on James navigating the ongoing pandemic successfully.

Direct Line Group key facts

  • Current 12m forward P/E ratio: 12.5
  • 10 year average 12m forward P/E ratio since floating in 2014: 11.2
  • Prospective yield: 8.5%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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First half results

Direct Line's largest division, Motor, recorded a 0.6% increase in gross written premiums to £805.3m and operating profit rose 43.4% to £220.5m. The division's combined ratio (the percentage of premiums paid out in claims or costs) fell from 95.1% to 81.9%, mostly due to lower claims during lockdown.

Home premiums fell 2.5% to £276.1m, reflecting the run-off of past partnership policies. Operating profit fell from £71.1m to £35.3m and the combined ratio rose from 82.8% to 92.4%. The reduction in profit can be attributed to storms Ciara and Dennis earlier this year and a particularly strong year in 2019.

Rescue & other premiums fell 3.0% to £210.1m as coronavirus impacted most products. Profits grew in Rescue but fell in Travel due to the pandemic. Commercial premiums rose 5.3% to £289.3m, and the impact of the pandemic was broadly neutral as lower claims frequency was offset by business interruption insurance.

The group still expects to achieve a 93-95% combined operating ratio this year, and expects to incur £60m in restructuring costs. The group still intends to bring operating costs down to 20% of premiums and current year underwriting up to 50% of profits in the next few years, although these plans may be delayed by the pandemic.

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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.

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