ii view: Direct Line shares dive to 2012 prices

The rising cost of car parts and higher used-car prices are feeding into claims inflation and hitting profits. We assess prospects.

First-half trading update

• Now expects to achieve a full year combined operating ratio of between 96% and 98%, down from previous expectations of 93% to 95%.

ii round-up:

Insurance company Direct Line Insurance Group (LSE:DLG) today warned shareholders about a spike in motor claims inflation and market volatility.

The FTSE 250 company adjusted its combined operating ratio target up to 96-98% from 93-95% previously. A figure below 100% means that it has earned more in premiums than it pays out in claims, but an increase points to lower annual profits. 

Direct Line shares fell by more than 10% in UK trading having come into this unscheduled update already down by just over a fifth in 2022 so far. Smaller rival Sabre Insurance Group (LSE:SBRE) recently warned that rising claims inflation was hindering its profits. Sabre shares are now down by more than 40% year-to-date, as are shares for sector giant Admiral Group (LSE:ADM). The FTSE All World index is down by around a fifth during 2022. 

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Higher used-car prices, longer repair times and inflation in the cost of car parts had all proved factors across the industry and are pushing claims inflation up.

However, Direct Line chief executive Penny James pointed to actions already taken to counter the profit headwind, including raising motoring policy prices. This, combined with ongoing actions to reduce costs, are expected to return the company's combined operating ratio back down to around 95% over the 2023 year ahead. 

Management also flagged a belief that its balance sheet and outlook for capital generation in the medium term remains strong, given pricing and operational improvements as it appeared to hint that the coming interim dividend should remain unchanged at 7.6p per share. 

However, given the current market environment, the insurer had decided not to launch the second £50 million tranche of a £100 million share buyback programme announced earlier in the year.

First-half results are scheduled for 2 August.   

ii view:

Launched in 1985, Direct Line today offers UK insurance policies both online and over the telephone to cover a variety of assets and events. Its original motoring insurance still generates the biggest slug of premiums at around half the total. Along with Direct Line, its other brands include Churchill, Darwin, Green Flag and Privilege.

For investors, the headwind of claims inflation has grown stronger and will remain a challenge. Changes under the FCA’s pricing review, effectively banning companies from raising the premiums of loyal customers, are now playing out, while events outside of management’s control like the weather can never be forgotten. A forecast dividend cover of 1.1 times is also below the three-year average of 2.2 times. 

More favourably, actions to help counter rising claims inflation are being taken, a diversity of insurances and not just motoring are offered, while chief executive Penny James is focusing heavily on data and technology.

While the high dividend is attractive, there is always a risk that the company will decide to divert its cash elsewhere and cut the payout if current conditions persist. It also remains unclear how long inflation will remain at elevated levels and remain an impact on group profits. Buyers at these prices must be willing to accept that risk.

Positives: 

• Diverse product offering 
• Attractive dividend payment (not guaranteed)

Negatives:

• Factors outside of its control such as the weather influence performance
• Forecast dividend cover of 1.1 times

The average rating of stock market analysts:

Buy