Direct Line Insurance Group (LSE: DLG) has been a strong performer this year, climbing by 7.1%, while its parent index, the FTSE 250, has fallen by nearly 3% since the New Year.
The gains appear to have been driven by the premium index published by Admiral Group‘s Confused.com website, which showed that the rate at which UK car insurance premiums are falling slowed to just 1.1% in the fourth quarter.
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However, I believe that the bulls have got ahead of themselves in re-pricing insurance firms’ shares on the basis of such flimsy evidence, especially as a different insurance premium survey, published by the AA, suggests that premiums fell by a more substantial 4.6% during the last quarter.
Should you sell Direct Line?
Although I think Direct Line is a decent firm, it’s worth remembering that it operates in a competitive industry that’s prone to exceptional costs, and offers relatively little in the way of growth opportunities.
Here are three reasons why I now rate Direct Line as a sell:
1. Weak earnings growth
Direct Line’s share price has risen by 23% since January 2013, but the firm’s earnings per share are expected to have risen by just 5% in 2013, and are forecast to rise by just 2% in 2014.
There doesn’t seem to be any reason to further re-rate Direct Line’s shares, given that earnings growth is expected to be very limited.
2. Vulnerable profits
Direct Line’s gross written premiums fell by 4.3% during the first nine months of 2013. This fall hasn’t yet been reflected in Direct Line’s operating profits, which rose by 20% in the same period, thanks to a comparison with the exceptionally wet summer of 2012, when Direct Line faced substantial bad weather losses.
These losses hit the firm’s underwriting profits hard, but that didn’t happen during the first nine months of 2013, boosting profits. However, a similar improvement in 2014 won’t be possible, and last December’s widespread flooding and property damage could well dent Direct Line’s fourth-quarter profits.
3. Are dividend expectations too high?
Current forecasts suggest that Direct Line will pay a total dividend of 14p for 2013.
However, the firm’s published dividend policy indicates that the final dividend will normally be twice the interim dividend. If this is the case, the firm’s total payout for 2013 will be 12.6p, giving a prospective yield of 4.8%, rather than 5.3%.
