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Direct Line Insurance Group plc could yield 7.5% in 2017

Image: Direct Line. Fair Use.

Tuesday’s results from insurance company Direct Line (LSE: DLG) suggest that it remains a strong income stock. While its performance in 2016 was negatively impacted by a change to the discount rate used to assess personal injury claim payouts, its outlook appears to be relatively upbeat. Since its shares have fallen by over 6% in the last month, its yield in 2017 could top 7.5%. Therefore, it seems to be one of the most enticing income stocks in the FTSE 100.

A difficult year

Of course, the recent news that the government was making a large change to the discount rate used for personal injury claims (the Ogden discount rate) came as a surprise to the motor insurance industry. It caused investor sentiment in Direct Line’s shares to decline and also meant that its profitability for the 2016 financial year was lower than expected. Despite this, the company was able to increase its final dividend by 5.4%, to 9.7p per share. This meant total dividends for 2016 were 24.6p per share, which included a special dividend of 10p per share.

Dividend growth prospects

Looking ahead, Direct Line will only pay one special dividend per year in order to better align its spending requirements. While a change in the Ogden discount rate means that the company’s future dividend payments are now less certain than they once were, the reality is that any higher costs incurred in claims by insurers such as Direct Line and peers such as Hastings (LSE:HSTG) are likely to simply be passed on to consumers. This will be in the form of higher premiums, which means that the overall effect on the company’s bottom line and its ability to pay dividends may be zero.

In fact, in the 2017 financial year Direct Line is due to pay total dividends of 26p per share. Following its recent share price fall, this means that it now has a forward yield of over 7.5%. Since it trades on a price-to-earnings (P/E) ratio of 11.9 versus a historic average over the last five years of 12.8, it seems to offer a margin of safety.

Sector peer

Direct Line’s attraction as an income stock is perhaps best evidenced when compared to a sector peer. Motor insurance specialist Hastings currently yields 4.7%. This is around 100 basis points higher than the FTSE 100’s dividend yield, but still lower than its sector peer. As with its industry rival, Hastings is likely to pass on to consumers the higher costs resulting from the change to the Ogden discount rate. Therefore, its forecast growth rate in earnings of 27% this year and 9% next year has a reasonable chance of being met.

However, since Direct Line is forecast to record a rise in its earnings of 34% this year and 4% next year, there is little to choose between the two stocks when it comes to earnings growth. But with such a large difference in yield and a similar prospects in terms of passing higher costs on to consumers, Direct Line seems to be the superior income stock for 2017.

5 top income stocks?

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Peter Stephens owns shares of Direct Line Insurance. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.