Direct Line Insurance Group (LSE:DLG) shares haven’t been the perfect choice for passive income of late. Dividends have been up and down since the pandemic and last year the FTSE 250 stock slashed the annual dividend by more than two-thirds.
To be fair, dividends have been falling across the London Stock Exchange in recent years. And what’s more, past performance is never a reliable indicator of what investors can expect.
In fact, City analysts expect dividends at Direct Line to increase rapidly over the next few years. And based on current forecasts, it could be said that the company is one of the FTSE 250’s most attractive income shares.
Dividend growth
To quickly recap, Direct Line slashed total dividends in 2022 to 7.6p a share, from 22.7p the previous year. This was in response to sky-high claims inflation that smacked its earnings and balance sheet.
Back then, Direct Line swung to a pre-tax loss of £45.1m, while its Solvency II capital ratio fell 290 basis points to 147%. This was outside its goal of mid-way between a range of 140-180%.
The good news is that City analysts expect the company to flip back into profit in 2023, and to continue growing the bottom line through to the end of 2025. This feeds predictions that dividends will also shoot higher, as the table below illustrates:
| Year | Dividend (f) | Annual growth | Dividend yield |
| 2023 | 9.9p | 30% | 5.6% |
| 2024 | 15.7p | 59% | 8.9% |
| 2025 | 18.7p | 19% | 10.6% |
As you can see, these forecasts also mean Direct Line shares offer yields comfortably above the 3.7% FTSE 250 forward average. In fact, dividends even hit double-digit percentages for 2025.
Fragile forecasts
But of course forecasts can’t be relied upon, and a sudden decline in trading conditions and the balance sheet can see dividends fall short of estimates.
In the case of Direct Line there are some serious red flags that need highlighting. Firstly, those predicted dividends are covered between 1.3 times and 1.6 times by expected earnings for the next three years. This is well below the widely regarded minimum safety benchmark of 2 times.
Tellingly, the company elected not to pay a dividend for the first half of 2023. Its Solvency II capital ratio remained flat at 147%, although it said the sale of its brokered commercial business will boost the ratio by 45%.
The verdict
So would I buy Direct Line shares to boost my passive income? At the moment my answer is no.
The firm has said it won’t start paying dividends again until a) its capital coverage returns to the upper end of its 140-180% target range, and b) its Motor division returns to organic cash generation.
The pressure to meet both of these metrics is high. Elevated claims inflation remains a problem across the insurance industry. So is the high level of competition in Motor insurance. Customers are driving away from Direct Line as they look for better deals (policy numbers dropped 3.2% in the first half).
The company has exceptional brand power. But this isn’t enough to make me buy its shares at the moment. I’d rather buy other FTSE 250 stocks for passive income.
