Why Admiral Group plc Could Be Forced To Cut Its Dividend

Admiral (LSE: ADM) has one of the most attractive dividend payouts. The company supports a trailing dividend yield of 7.2% and the consensus among City analysts is that this payout will continue for the next few year. City forecasts have pencilled in a dividend yield of 7.5% for 2014 and 7.1% for 2015. 

However, some analysts have begun to call into question the sustainability of this payout, as Admiral has recently tapped the market for extra cash to boost its capital position.

Price pressuresadmiral.2

According to survey data, the average UK car insurance premium is falling. Thanks to the rise of price comparison sites, competition is becoming aggressive with each insurer trying to undercut each other. And it’s not just Admiral that is being affected, the company’s peers, Esure (LSE: ESUR) and Direct Line (LSE: DLG) are also feeling the pressure. 

Unfortunately, as premiums fall, claims costs are rising and profits are evaporating, car insurance has never been a profitable business. 

Indeed, last year was the first year that the industry as a whole made an underwriting profit since 1994. That being said, Esure, Admiral and Direct Line have managed to grow profits by keeping costs under control, although claims costs continue to rise. 

direct lineReserve release 

To boost profits this year, Admiral tapped its reserves, releasing funds to bulk up income from operations. In other words, management tapped funds built up during previous years. As you can guess this is not a sustainable, long-term strategy, one day the reserves will run out. 

Admiral has already attracted criticism for using the reserve release strategy.

For example, during the first half of this year the company’s revenue fell 5%, despite gaining 340,000 more customers. What’s more, the insurer released £73m from reserves to help keep half-year pre-tax profits little changed at £183m.

While these figures are concerning, what really shocked analysts was the fact that the company then decided to tap the market for £200m in bonds, to boost its capital position. Some analysts have interpreted the bond issue as a sign that the insurer cannot afford the hefty dividend payout. 

Peer pressure

If Admiral’s dividend payout is for the chop, then the payouts of Esure and Direct Line are likely to be facing the same fate.

Admiral is one of the UK’s most efficient insurers and more profitable than most, with an expense ratio equal to 20% of premiums. Direct Line’s cost ratio is closer to 30%, however, analysts estimate that the company could cut up to £1bn per annum of the group’s cost base. 

Still, at present levels Direct Line is expected to offer investors a dividend yield of 6.5% this year, followed by 6.3% during 2015. Esure is expected to support a yield of 6.6% this year followed by 7% during 2015. For the time being these payouts look safe but it always pays to build a well-diversified portfolio of reliable dividend paying stocks allowing you to reduce risk and sleep soundly at night.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.