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How Direct Line Insurance Group PLC Will Deliver Its Dividend

I’m looking at some of your favourite FTSE companies and examining how each will deliver their dividends. Today, I’m putting Direct Line Insurance Group (LSE: DLG) under the microscope.

Dividend policy and history

Direct Line was floated on the stock market as recently as October 2012. In announcing the flotation the company said, in clipped language:

“Intention to pay full final dividend for the 2012 financial year … (final dividend to represent two-thirds of pro-forma full year dividend). Pro-forma full year dividend pay-out ratio for the 2012 financial year expected to be between 50-60% of any consolidated post-tax profit from the Group’s ongoing business [excludes Run-off and Restructuring and other one-off costs]. Progressive dividend policy thereafter”.

Direct Line paid an 8p final dividend for 2012, implying a pro-forma 2012 interim of 4p.

The company released its first-half results for 2013 earlier this month. The board announced an interim dividend of 4.2p, representing an increase of 5% on the pro-forma 2012 interim. The directors said:

“The Group’s progressive dividend policy aims to increase the dividend annually in real terms. If trends in the second half of 2013 follow those in the first half of 2013, the Group expects the growth in the final dividend to be at a similar level to that of the interim dividend”.

The board also stated specific circumstances in which the company would consider returning capital to shareholders over and above the ordinary dividend:

“The Group’s current risk-based capital coverage ratio of 147.6% (adjusted for interim dividend) is within the 125% to 150% target range. The Board will continue to review the capital adequacy of the Group and if it believes the Group has capital surplus to requirements, indicated by the expectation of a risk-based capital coverage ratio significantly in excess of this range for a prolonged period, it would consider returning surplus capital to shareholders. In the event of any proposal to return capital to shareholders this would be expected to occur concurrently with any proposed final dividend.”

Despite Direct Line’s short life on the stock exchange, the directors have given shareholders and potential investors one of the most specific and concrete dividend policies you’ll find among the 600-odd companies of the FTSE All-Share market.

Dividend prospects

As we know, Direct Line expects to increase the final dividend at the same rate as the interim if trends in the second half of 2013 follow those of the first half. That would give an 8.4p final dividend to go with the 4.2p interim, making a full-year dividend of 12.6p. Analyst earnings forecast suggest a dividend payout ratio in the same 50-60% range as last year.

The company’s shares are currently trading at 217p, so the dividend yield is 5.8% — some 1.8 times the market average. Why such a high yield? Well, investors are cautious: the company’s not only new to the stock market, but it’s a competitive world out there right now for all insurers, and Direct Line needs to execute on a transformation and cost-cutting plan.

Direct Line could deliver and reward income investors handsomely, but I can tell you there’s a big blue-chip company that also yields 5.8%, but operating within a far less competitive industry.

The Motley Fool’s chief analyst believes this company is currently the UK’s top income stock. Furthermore, he reckons fair value for the shares is 850p compared with 741p today. You can read our leading analyst’s in-depth review of the company in this exclusive free report.

The report comes with no obligation and can be in your inbox in seconds — simply click here.

> G A Chester does not own any shares mentioned in this article.