Today (Monday, 13 July) has not been a good day for shareholders of Direct Line Insurance Group (LSE: DLG). That’s because Direct Line shares have taken a tumble, following a profit warning from the well-known general insurer.
Direct Line shares dive
As I write, Direct Line shares hover around 187p, down 13.6% since Friday’s close. This followed a trading update and profit warning from the company before the market open.
The owner of Churchill Insurance and roadside-assistance provider Green Flag warned of “heightened volatility across the UK motor insurance market”. Inflation has hiked the cost of motor claims, so Direct Line has reduced its combined operating ratio target for 2022 to 96%-98%.
The combined operating ratio adds total claim losses and expenses and then divides by total premiums. Ratios under 100% are profitable, while ratios over 100% indicate losses. Thus, a target ratio of 96%-98% means Direct Line is profitable, but only by 2%-4% of premium income. Typically, a ratio of, say, 75%-90% would be attractively profitable for general (non-life) insurance products.
Insurance premiums on the rise
Direct Line has responded by increasing quoted premiums and re-pricing to restore margins. The firm expects this to improve its combined operating ratio for 2023 to 95%, with a medium-term target of 93%-95%. Overall, the group expects a combined operating ratio for H1/2022 of 96.5%, and total premiums of around £1.52bn.
In view of these factors, the board decided not to start the second £50m tranche of £100m of share buybacks announced earlier this year. However, one piece of good news for shareholders is that Direct Line’s chunky dividend looks safe — for now. The group said its “strong balance sheet…gives us confidence in the sustainability of our regular dividends for this year and as we look ahead”.
Would I buy Direct Line stock today?
Here’s a quick recap of the range of Direct Line’s share price over the past 12 months:
| 52-week high | 319.4p (4 August 2021) |
| 52-week low | 184.7p (18 July 2022) |
| 12-month change | -35.3% |
As you can see, the Direct Line share price hit a 52-week low of 184.7p earlier today, before bouncing slightly to 187p. This leaves it 41.2% down from the 52-week high set in August 2021. Ouch.
Here’s how the group’s trailing fundamentals stack up today:
| Market value | £2.8bn |
| Price-to-earnings ratio | 7.9 |
| Earnings yield | 12.7% |
| Dividend yield | 12.0% |
| Dividend cover | 1.1 |
As these are backward-looking figures, Direct Line’s price-to-earnings ratio is set to rise, thus lowering its earnings yield. For me, this suggests that this year’s dividends may not be fully covered by operating earnings. That said, a dividend yield of 12% makes this FTSE 250 stock one of the highest-yielding in the entire London market.
Looking at Direct Line’s bumper dividend yield, I’m tempted to take a punt by buying these shares. I spent 15 years in the insurance market, so I know this is a quality business. After all, it’s been around since 1985, listed in London for almost 10 years, and has over 10,000 employees. But I might well wait until after the group publishes its half-year results on Tuesday, 2 August!
