Direct Line’s shares may not be motoring but the 6pc yield makes them a hold
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
Share price at close: 317.3p