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3 Things To Loathe About Direct Line Insurance Group PLC

There are things to love and loathe about most companies. Today, I’m going to tell you about three things to loathe about Direct Line Insurance Group (LSE: DLG).

I’ll also be asking whether these negative factors make Direct Line a poor investment today.

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Short history

Although Direct Line has been around since 1985 — and became the wholly-owned insurance arm of Royal Bank of Scotland during 1988 — the company has only been on the stock market since October 2012.

We have little in the way of accounts and a performance record, because Direct Line has been operating as a standalone company for barely more than a year. As such, the firm is unproven as a corporate entity in its own right.

Royal Bank of Sell-land

RBS sold a 35% share of Direct Line in the 2012 flotation at a ‘priced to go’ 175p a share, and disposed of a further 17% during March this year at 201p a share. At the latter date RBS’s stake in the insurer was on the bank’s books at 216p a share — and that’s what Direct Line’s shares are trading at today.

RBS must dispose of its remaining stake in Direct Line by the end of 2014 under conditions imposed by the EU when the bank was bailed out with £45bn of taxpayers’ money. So, within the next 14 months just under 50% of Direct Line — over 725 million shares — will have to find a new home. That suggests the prospect of a big uplift in the share price is remote for the foreseeable future.

A dog-eat-dog world

Direct Line — which owns several other businesses, including insurer Churchill and car breakdown brand Green Flag — is busy ruthlessly cutting costs as competition within the industry has become intense. Oh yes, it’s a dog-eat-dog world out there.

Despite Direct Line’s investment behind its brands, retail insurance is becoming increasingly commodified. Rampant price-cutting and passing potential profits on to punters rather than shareholders is the order of the day in a grinding battle for market share.

Comparison websites and the ease of online research are the second-nature tools of each new cohort of car and homeowners. In fact, even my Mum and her pensioner friends are ditching brand loyalty in favour of price-savvy choices. I reckon shopping around for services where there’s little differentiation other than price is becoming increasingly embedded in the national psyche.

A poor investment?

For me, the three things to loathe about Direct Line do make the company a poor investment — or, to be more generous, I see better investment opportunities elsewhere within the stock market.

Having said that, if your assessment of the company is contrary to mine — and you’re right — Direct Line could prove a rewarding investment at 216p. The current-year forecast price-to-earnings ratio is a below-market-average 11 and there’s a forecast high-octane dividend yield of 5.9% on offer.

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You see, our top income analyst believes this company, which currently offers a 5.7% yield, will provide investors with steady annual dividend growth for many years to come. Not only that, but he calculates the stock is trading today at 100p a share below current fair value of 850p.

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

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