Direct Line Insurance Group plc (DLG) Ordinary Shares 10.9090909p
HL comment (21 November 2019)
Direct Line has released a strategy update, alongside third quarter results.
That's ahead of the group's first ever Capital Markets Day, where institutional investors and analysts will meet management. The group also said that at the shares' current valuation, the Board's preference is to return surplus capital to shareholders through share buybacks instead of through special dividends.
Direct Line shares were up 7.5% in early trading.
Personal insurance can be a tough industry.
It's highly competitive, and with rivals offering pretty generic products, few companies can maintain any semblance of pricing power. That tends 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. The industry at large has struggled with technical changes to the way personal injury claims are valued either - increasing the reserves insurers need to hold. The changes set DLG back around £15.9m in the first half.
Against this backdrop, new CEO Penny James has updated the market with a strategy firmly focused on cutting costs and leveraging recent investments in technology. The goal is to bring the group's operating costs down to 20% of premiums by the end of 2023, compared to 23.4% last year. While the cost of the IT upgrade will weigh in profits, James reckons lower capital spending going forward and £50m of cost cutting can generate an extra £100m of capital each year.
In recent years profits have been flattered by the release prior years' reserves. That's unsustainable, 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.
The other big news is that the group looks set to favour share buybacks over special dividends going forwards. That will significantly reduce the prospective yield and potentially makes it easier for management flex total shareholder returns. Although, on the bright side it could provide some support to the share price over time.
Overall we think the new targets are ambitious but not unachievable - although a lot's riding on the group's new technology investments living up to their billing. The PE ratio of 10.2 prior to the announcement is below the long run average, reflecting the challenges ahead.
Third Quarter Results
Overall third quarter premiums rose 0.4% to £858m, with own brand premiums also up 0.4% to £612.7m.
Motor gross written premiums (GWPs) were up 0.3% to £457.8m on the back of strong trading from Churchill on price comparison sites. Momentum has continued into the fourth quarter, but the group continues to see claims inflation towards the upper end of its 3-5% long run expectations range.
In Home, GWPs were down 4.9% to £158.6m as white label partnerships came to an end. Claims inflation was below long run expectations. Meanwhile, Commercial GWPs were up 5.3% to £124.2m as Direct Line for Business did well with small business and tradespeople. Early estimates for the November flooding costs are around £10m across both Home and Commercial.
Rescue and other personal lines GWPs were up 3.5% to £117.4m. Green Flag passed one million in force policies, and GWPs were up 15.5%.
In total, Direct Line had 14.8m in force policies, down 2.3% on last year. Of these 7.2m were own brand, an increase of 2.2%.
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Previous Direct Line Insurance Group plc updates
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