The Pros And Cons Of Investing In Direct Line Insurance Group plc

Stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at Direct Line Insurance Group (LSE: DLG) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

Rising competition crimps performance

Direct Line is at the mercy of increasing competition across all of its main markets in the UK, a phenomenon that pushed gross written premiums 4.3% lower during January-September to £2.95bn.

Indeed, in-force policies at its Motor division have fallen 6.4% as of the end of September from the close of 2012, which the company attributes to its “focus on maintaining its underwriting discipline in a competitive marketplace.” And elsewhere, active Home insurance policies have fallen 1.7% during the same period.

An expansive product portfolio

Still, Direct Line benefits from the strength of diversity through its multi-pronged approach to the insurance industry, and is one of the UK’s leading providers of home, motor, travel and pet insurance. And the firm’s tentacles are now extending into other rapidly-expanding areas, including landlord and van coverage.

Direct Line is also at the forefront of new innovations in the insurance sector, and is, for example, a leading light of telematics technology in the industry. The firm has seen demand for these policies — in which a ‘black box’ is fitted to your car to monitor your driving behaviour — ratchet higher in recent months, and Direct Line is installing around 400 devices per week at the moment. British comparison website estimates that, by 2017, around 57% of the country’s drivers will be running a telematics-based car insurance policy.

Competition to stymie near-term earnings growth

Still, earnings are expected to dip in 2013, according to broker estimates, as the impact of increased competition hampers revenues. Indeed, turnover is expected to dip 7% this year to £3.77bn from £4.05bn in 2012.

This is anticipated to contribute to a 4% earnings per share (EPS) decrease this year, to 21p, although the effect of improving income and robust cost-cutting measures are expected to boost EPS by 9%, to 22.9p, in 2014.

Check out that monster yield

Direct Line is expected to rev up dividends in coming years, and there’s already been a 75% hike from 2012’s 8p per share full-year payout to 14p this year is expected. This would leave the company dealing on a current dividend yield of 6.3%, smashing the 3.3% FTSE 100 forward average, as well as beating the 4.5% average of its non-life insurance rivals.

In my opinion Direct Line offers fantastic value as both an income and growth stock, with a prospective P/E reading of 10.9 outstripping a relative multiple of 12.5 for the rest of its sector. Given the firm’s extensive, and in many cases market leading, operations across multiple sectors, not to mention expanding presence in juicy foreign markets, I expect earnings to swing significantly higher.

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> Royston does not own shares in Direct Line Insurance Group.