Direct Line: Mega yield is reward for high risk

by Graeme Evans from interactive investor |

The yield is among the best available, and some believe these FTSE 100 shares are undervalued. 

A squeeze on motor insurance profitability kept shares in Direct Line (LSE:DLG) in reverse gear today, heightening focus on one of the highest-yielding stocks in the FTSE 100

The stock has now erased the impressive gains achieved in the first quarter of 2019, with today's update on the competitive conditions currently facing the owner of brands including Churchill, Privilege and Green Flag helping to trigger another 2% fall to 312p.

That could put Direct Line in the shop window for some income investors, given the company's forward yield of 8.8% and record of share price resistance at the 300p barrier. That was underlined by Peel Hunt's decision to reiterate its target price of 380p today.

Source: TradingView   Past performance is not a guide to future performance

But the stock is not without its risks, with 2019 already billed by the UK's biggest car insurer as a pivotal year of operational delivery with the roll-out of new IT systems on personal lines.

A disruptive Brexit could still impact the group's investments, in particular credit spreads related to its debt and group solvency. There are a range of other operational considerations, including on goods such as car parts currently sourced from the EU.

And as today's trading update showed, claims inflation has been at the upper end of the group's long-term expectations of between 3% and 5%. Operational and technological enhancements can help Direct Line to offset this pressure, but in the meantime market premiums in motor insurance are failing to keep pace with the claims growth.

Gross written premiums in the motor segment fell 4.2% to £386.9 million, with the number of in-force policies flat in the quarter. Direct Line's home insurance segment is faring better, with own-brand premium levels broadly stable in a competitive market.

Direct Line now appears on price comparison websites for the first time following the recent launch of its Darwin brand.

Chief financial officer Penny James, who takes over as CEO this month following the departure of long-time boss Paul Geddes, added that the roll-out of new systems in motor and travel had gone well so far as the group looks to improve competitiveness and customer experience.

She repeated existing targets, including a reduction in operating expenses to below £700 million from £722.2 million in 2018 and £806.3 million in 2017. The target for a combined operating ratio of 93% to 95% in 2019 and over the medium term compares with 91.7% in full-year results after a benign year of weather in 2018.

The group's strong capital generation recently resulted in a special dividend of 8.3p alongside a 2.9% increase in the final dividend to 14p a share. 

However, the special divi was down from the 15p a year earlier as the insurer raised its solvency capital ratio to 170% in order to reflect political and economic uncertainty.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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