I’ve been bearish on Lloyds Banking Group for some time because I think the firm’s extreme cyclicality makes the stock a questionable choice for a dividend-led investing strategy. I think investors face limited potential upside and elevated downside risks with Lloyds today, and the outlook for investor total returns looks murky to me.
Instead, I’d rather go for the FTSE 100’s Direct Line Insurance Group (LSE: DLG), which is sporting a dividend yield of just over 8%. I admit that there’s a fair bit of cyclicality in the firm’s insurance operations, but I don’t think it’s quite as vulnerable to negative effects from any future general economic slowdown as Lloyds is.
Giving customers a good reason to buy
People need insurance for their cars, homes and businesses, even in economic slowdowns, and I reckon Direct Line is well placed to weather economic storms. The company works hard to attract customers to its direct own brands by giving benefits that other insurance firms don’t offer via comparison websites.
There’s also a focus on being easy to deal with, such as making it possible and simple for customers to get quotes from the firm’s website and move right through to placing the order for insurance without having to speak to anyone on the phone.
The company’s approach certainly works for me. I find I have nearly all my insurance with Direct Line – two cars, home and business insurance. I’d be reluctant to switch suppliers but would do so if the cost of insurance became uncompetitive. Nevertheless, I’m a loyal customer to Direct Line and I suspect many others are too, which encourages me to believe that the business model is strong enough to support ongoing dividend payments through the wider economic cycle.
But Direct Line also has a toe in the price comparison website market with its Churchill and Privilege brands. The company said in today’s full-year results report it believes it has the opportunity to strengthen margins in that channel to market.
The strategy is working
In the report, the company described the insurance market as “highly competitive,” which is no surprise given the sheer number of players in the game. However, the company’s “resilient business model” has delivered one million new direct own-brand policies since 2014, which is a statistic that suggests the firm’s strategy is working.
During 2018, the company stopped trading partnerships with Sainsburys and Nationwide for home policies, which led to a 5.3% reduction in gross written premiums compared to 2017. However, the gross written premium from direct own brands rose 1.8%. Overall, operating profit eased back 6.4% and profit before tax rose by 8.1%. The directors expressed their confidence in the outlook by pushing up the total ordinary dividend for the year by 2.9%, although the special dividend eased back by 44.7% this year.
The current chief financial officer, Penny James, will step up to the role of chief executive in May, which I see as positive. I think a change at the top can often usher in a period of new vitality and enthusiasm in any company, which could reflect in investor total returns down the line. Overall, I see the shares as tempting.
