Di­rect Line’s shares may not be mo­tor­ing but the 6pc yield makes them a hold

The Sunday Telegraph - Money & Business - - Business - Read Questor’s rules of in­vest­ment be­fore you fol­low our tips: tele­graph.co.uk/go/questor­rules; twit­ter.com/dtquestor

THERE are three things you should know about Paul Ged­des, the chief ex­ec­u­tive of Di­rect Line. He re­ally fancied run­ning ITV when Adam Crozier stepped down last year but can con­sole him­self with a board seat at Chan­nel 4 in­stead. He plays vi­o­lin with the West­min­ster Phil­har­monic Orches­tra and has been known to per­form at friends’ wed­dings. And his lead­er­ship of the in­sur­ance com­pany still best known for the red tele­phone on wheels has re­sulted in one of the best-per­form­ing stock mar­ket flota­tions this decade.

A group of wise pri­vate in­vestors will have known at least the last – and most salient – of those three points. When Di­rect Line was spun out of Royal Bank of Scot­land in 2012 at the be­hest of Brus­sels as the price for the state aid re­ceived when it was bailed out by the tax­payer, around 15pc of the shares of­fered were bought by small share­hold­ers. It was clear very quickly they had done well.

Many ob­servers were scep­ti­cal at the time, es­pe­cially as pri­vate eq­uity firms could not be per­suaded to take the in­surer off the hands of RBS. Mo­tor in­sur­ance is a no­to­ri­ously com­pet­i­tive mar­ket char­ac­terised by thin mar­gins. How­ever, priced at 175p, Di­rect Line shares dou­bled in less than two and a half years as costs were squeezed and the com­pany bet­ter cap­i­talised on its scale. They have traded in a rea­son­ably nar­row band ever since. That was un­til sum­mer, when they be­gan to drift south af­ter Ged­des an­nounced he would step down next year.

His de­ci­sion to de­part co­in­cides with a de­cid­edly mixed out­look. In its re­cent re­view of non-life in­sur­ers, an­a­lysts at Bar­clays sug­gested that the worst of the price de­clines in the mo­tor sec­tor could be over. The cost of put­ting a car on the road has been fall­ing be­cause of an­tic­i­pated changes to how com­pen­sa­tion for per­sonal in­juries will be cal­cu­lated, which are ex­pected to re­duce du­bi­ous whiplash claims. But at the same time, claims in­fla­tion has bounced back to Di­rect Line’s long-term 3pc-5pc range.

An­a­lysts at Shore Cap­i­tal pointed out that the com­pany’s con­sen­sus-beat­ing half-year re­sults in Au­gust owed much to a higher re­lease of re­serves – funds no longer re­quired to be held against live poli­cies – whereas the at­tri­tional loss ra­tio of 70.5pc in the cur­rent year – a mea­sure of claims paid out di­vided by pre­mi­ums earned – was around two per­cent­age points worse than ex­pected.

How­ever well they are run, in­sur­ers must con­tend with some fac­tors be­yond their con­trol, such as the weather. It was mainly the freez­ing con­di­tions caused by the Beast from the East that led to £75m in weath­er­re­lated claims in the first half, up from £9m, al­though the sum­mer heat­wave is also ex­pected to have caused more crashes as well as house sub­si­dence.

The holy grail is cus­tomer re­ten­tion and Di­rect Line, whose ad­ver­tis­ing now stars the Amer­i­can ac­tor Har­vey Kei­tel, has re­sisted be­com­ing a slave to price-com­par­i­son web­sites. A shift to sell­ing more poli­cies un­der its own brands such as Churchill, Priv­i­lege and Green Flag – which cur­rently num­ber 7m out of the 15.3m poli­cies in force – looks like a smart one. But pulling back from part­ner­ships with Na­tion­wide and Sains­bury’s cost it in the short term as pre­mi­ums at its home di­vi­sion dropped by 25pc in the last re­ported pe­riod.

All of these vari­ables did not de­ter Bain Cap­i­tal from tak­ing over mo­torin­sur­ance ri­val Esure in the sum­mer for £1.2bn. How­ever, the buy­out group is pay­ing less than the float price from five years ago, re­flect­ing the trou­bled time Sir Pe­ter Wood’s ven­ture en­dured on the pub­lic mar­kets.

Di­rect Line share­hold­ers can take com­fort that the group’s 169pc sol­vency cap­i­tal ra­tio – up from 165pc in the pre­vi­ous year – re­mains com­fort­ably within the com­pany’s 140pc-180pc de­clared range and means the aim to grow the div­i­dend in line with the busi­ness looks safe.

In­vestors never look in the rearview mir­ror, even when it comes to car in­sur­ers. Last year’s 15p-per-share spe­cial div­i­dend is a dis­tant me­mory but more of the same is not im­pos­si­ble. Even with­out top-ups, Di­rect Line stock yields an at­trac­tive 6.4pc. While it is not clear what the cat­a­lysts are that will get the shares mo­tor­ing again, the promised pay­out makes them well worth hold­ing.

Questor says: hold

Ticker: DLG

Share price at close: 317.3p

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