The Direct Line Insurance Group (LSE:DLG) share price has sprung recently. Yet at current levels it still offers stunning double-digit dividend yields.
The insurance giant has a long history of delivering market-beating dividend payments. And for 2023, it carries a 7.7% dividend yield, far ahead of the 3.2% average for FTSE 250 shares.
Things get even better for 2024 too. Then the dividend yield marches to 10.9%.
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But just how robust are current dividend forecasts? And should I buy Direct Line shares for my investment portfolio?
Rapid dividend growth
As I say, Direct Line has a proud record of paying excellent passive income to its investors. But the company’s dividend history has been more checkered of late as cost pressures have weighed.
In 2022, the insurer paid a total dividend of 7.6p per share, down significantly from 22.7p the year before. This reflected the firm’s decision not to pay a final dividend as high claims inflation caused it to swing to a £45.1m pre-tax loss.
But City analysts expect this to be a rare blip. In fact they expect annual dividends to grow strongly over the next two years as Direct Line grows profits again.
Total dividends are expected to rebound to 12.9p per share in 2023 before rocketing to 18.3p next year.
Weak forecasts
But will Direct Line realistically be able to pay the dividends analysts are expecting? I’m not convinced.
First of all, predicted dividends are covered between 1.4 times and 1.6 times through to 2024. This is well below the widely accepted safety benchmark of 2 times and above that provides a decent margin of safety.
This is especially worrying given the deterioration in the company’s capital position. A weakening balance sheet means it could have less wiggle room to pay big dividends if earnings disappoint.
Direct Line’s Solvency II capital ratio dropped rapidly to 147% at the close of December, down from 176% a year earlier.
Should I buy Direct Line shares?
The good news for Direct Line is that car insurance premiums are rising strongly. This is critical as its Motor unit is responsible for almost half of all gross written premiums.
Price comparison website Confused.com says the average UK motor premium sits at £657. This is up 20% year on year and the highest level since 2011.
The trouble for motor insurers is that higher revenues are being swallowed up by rocketing claims inflation. The Association of British Insurers says that higher energy costs alone are adding an extra £71.75 to each repair claim. The cost of other items like paint, labour, courtesy cars and second-hand vehicles also continue to balloon.
The verdict
At the same time, Direct Line’s ability to boost revenues is undermined by a highly competitive insurance environment.
Big hitters like Admiral, Aviva and Hastings are all vying to attract customers by offering the lowest premiums. It’s a bloody fight that is hampering their ability to make decent profits. RSA Insurance’s decision last month to withdraw from the motor market illustrates this point perfectly.
Direct Line’s dividend yields are highly attractive. But all things considered I’m happy to ignore the insurer’s shares today. I’d rather buy other shares for passive income.
