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Direct Line - buyback announced, strong results

Sophie Lund-Yates, Equity Analyst | 8 March 2022 | A A A
Direct Line - buyback announced, strong results

No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Direct Line Insurance Group plc Ordinary

Sell: 216.50 | Buy: 216.90 | Change 0.50 (0.23%)
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Direct line's full year gross written premiums fell 0.3% to £3.2bn, of which £2.2bn were own brand policies, down 0.8% year on year. The decline partly reflects reduced Motor policies. The group's combined operating ratio, which is the percentage of premiums paid out in claims and operating costs, improved to 90.1% from 91.0%.

Operating profit rose 11.4% to £581.8m.

The group declared a final dividend of 15.1p per share and announced a £100m share buyback.

The group said there's a "range of inflationary pressures" but is working to offset these with cost savings.

The shares rose 4.1% in early trading.

View the latest Direct Line share price and how to deal

Our view

We should lead with Direct Line's prospective yield. A prospective dividend yield above 9% should be met with alarm bells rather than applause in the current environment. A large part of why the yield's so high, is the reduction in Direct Line's share price.

It's true that on the face of it, the group's profits are now covering the dividend - an area we were concerned about previously. But only just. And there are some challenges remaining meaning we can't rule out changes to shareholder returns.

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.

New rules also mean insurers will no longer be allowed to automatically hike home and car renewal quotes. This is a headwind felt by the whole industry. However, we must admit that amongst this unhelpful development, Direct Line's ability to keep its medium-term targets intact is no mean feat.

We're also encouraged by Direct Line's strong retention rates in key areas, made more difficult by changes to automatic renewals. The money invested in launching a new integrated Motor platform should also help with this in the long run, as well as boosting efficiency (more on that later).

One of Direct Line's key advantage is its brand. This has helped it price more aggressively than competitors and also secure a relatively high proportion of direct sales (without selling though price comparison sites). The second is scale, because the new, leaner cost base can be spread across more policies. New technology infrastructure helps the group compete on price comparison sites, and is improving underwriting accuracy.

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 not a long-term source of growth, so we're also heartened to see reserve releases becoming a less significant part of total profit.

CEO Penny James has instead focused on cutting costs, capitalising on recent investments in technology and increasing the contribution of underwriting.

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. Direct Line has a strong offering in a difficult market. The challenges are reflected in a below-average price to earnings ratio, which could rerate should we see continued accelerated momentum. As ever, all share prices can go down as well as up.

Direct Line Group key facts

  • 12m forward Price/Earnings ratio: 9.4
  • Average Price/Earnings ratio since listing (2012): 11.2
  • Prospective yield (next 12 months): 9.5%

All ratios are sourced from Refinitiv. 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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Full year results

The Motor business is "already seeing the benefits" of the new Motor platform and its "improved pricing sophistication through increased competitiveness". Claims are still below pre-pandemic levels, and claims severity inflation was higher than the 3-5% medium term expectations.

Gross written premiums fell 3.5% to £1.6bn. Claims frequency increased back to normal levels in the second half, as restrictions eased and more people were driving. Overall, the division's combined ratio increased 4.7 percentage points to 92.4%, and operating profit fell 13.4% to £314.8m.

Home operating profit rose to £141.8m, from £101.4m, largely because of lower weather-related costs and higher prior-year reserve releases. Gross written premiums of £577.8m were broadly flat compared to 2020, while net claims fell to £280.4m from £301.9m.

Green Flag Rescue and Other Personal Lines premiums fell 9.1% to £380m, while operating profit rose to £64.8m from £6.8m. The large swing in profit reflects improved travel insurance trends and increased profitability in roadside rescue.

Commercial premiums rose 15.0% to £653m, and operating profit rose from £50.4m to £60.4m.

The group's Solvency II capital ratio stands at 176%, after including shareholder returns, down from 191% in 2020. This was within the "stated risk appetite range of 140% to 180%".

Find out more about Direct Line shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.