The Direct Line Insurance Group (LSE:DLG) share price has slumped 23% in 2022. Based on current dividend forecasts, this decline leaves Direct Line shares with an 9.5% dividend yield.
This reading sails past the forward average of 3.2% for FTSE 250 shares. And the insurer’s dividend yield marches to an even-better 10% for 2023.
But how realistic are current dividend forecasts? And should I buy Direct Line shares for my portfolio?
A bumpy ride
Like many UK shares, Direct Line cancelled the dividend at the height of the Covid-19 crisis. Since then, it’s pulled ordinary payouts back to pre-pandemic levels and handed out special dividends too.
But with earnings tipped to fall by a third in 2022, the company’s ordinary dividend is projected to fall again. It’s predicted to drop to 20.9p per share from 22.7p last year.
On the plus side, Direct Line is tipped to hike dividends to 22.1p per share in 2023. This is supported by an expected 46% year on year earnings increase.
Fragile forecasts
The trouble I have as a potential investor however, is that this year’s dividend projection is lower than predicted earnings of 16.5p per share.
And next year the expected shareholder payment is barely covered by estimated earnings of 24.1p per share. Dividend coverage below 2 times doesn’t give investors a wide margin of safety.
Having said that, Direct Line has a great history of generating cash. And in June, it had £681.3m of cash and cash equivalents on its balance sheet. It could therefore have enough balance sheet strength to meet the City’s dividend projections if earnings forecasts miss.
But then the insurer’s balance sheet has been weakening in 2022. If it continues this downtrend the business may have neither the will nor the financial strength to pay more big dividends. Direct Line’s solvency ratio fell 8% in the six months to June, to 152%.
Premiums drop
High inflation is a huge problem for the insurance industry right now. And insurers are having to raise premiums to safeguard their margins.
The trouble is that Direct Line’s premiums are sinking as a result. Adjusted gross premiums dropped 3.5% in the nine months to September, to £2.3bn. This was caused by huge reversals at its core Motor and Home divisions. These premiums dropped 8.9% and 10.1% respectively year on year.
The business has taken steps at its garage repair network to reduce the problem of high costs. But inflation looks set to remain a thorn in the industry’s side well into 2023 and perhaps beyond.
And in a highly competitive industry raising premiums is very risky business. The number of in-force policies at Direct Line dropped more than 10% between January and September to 13,086 as it hiked prices.
The verdict
This steady erosion in premiums could ease if Direct Line doubles down on marketing. The business has some of the strongest industry brands out there.
But as things stand the business looks set for another difficult year in 2023. And given the fragility of its dividend forecasts, I’d rather buy other UK income stocks today.
