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Dividend dynamo or investment trap? A FTSE 100 income stock I think deserves your attention

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The crushing competition in the car insurance market has been a millstone around the neck of Direct Line Insurance Group (LSE: DLG) in recent times.

They are fears reflected in the company’s dirt-cheap valuation, a forward P/E ratio of 11.7 times, which sits just above the bargain-basement benchmark of 10 times (and below). The share price has risen 17% since mid-December though, and I’m confident that it can continue to tear higher in the weeks and months ahead.

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A brilliant brand

A brilliant set of full-year financials released in recent days certainly gives grounds for me to make such a confident prediction. In this latest statement, the FTSE 100 firm advised that while gross written premiums slipped 5.3% in 2018 to £3.21bn, pre-tax profit actually sailed 8.1% higher year-on-year to £582.6m. This was chiefly down to higher finance costs in 2017 that were related to debt repurchases.

That decline in written premiums last year was down to Direct Line’s exit from partnerships with significant market players Nationwide and Sainsbury’s, so this doesn’t spook me for one minute. In fact, news that gross written premiums of its own brands rose 1.8% in 2018 to £2.22bn gives cause for celebration, as does news that premiums grew across all of its insurance segments.

The Footsie firm has seen 1m new customers take out one of its own-brand policies during the past four-and-a-bit years, underlining the brilliant brand power and strength of its products, allowing it to sidestep the challenging market backdrop battering many of its competitors.

8% dividend yields

The strong results of 2018 prompted Direct Line to not only hike the full-year ordinary dividend to 21p per share, from 20.4p previously, but also to pay another special dividend totalling 8.3p.

Things are looking pretty good for the insurer to keep forking out gigantic dividends too. It has proven its resilience in challenging times and is expected to remain so, as indicated by broker predictions of another 2% earnings rise in 2019. And it also has a rock-solid balance sheet thanks to its exceptional cash-generative qualities. Its solvency capital ratio rose to 170% after dividends last year, up 500 basis points from 2017, and sitting at the upper end of Direct Line’s targeted ratio of between 140% and 180%.

As I type, City analysts predict a total dividend of 28.1p for 2019, a gigantic year-on-year jump that leaves a market-mashing yield of 8%.

Now it’s worth bearing in mind the strains that the UK’s withdrawal from the European Union may inflict on the company’s progressive dividend policy. Indeed, Direct Line has outlined plans to keep its solvency capital ratio towards the top end of guidance given “the high level of political and economic uncertainty, including in relation to Brexit.”

Even if this issue does hamper near-term dividend growth though, it’s more than likely the forthcoming full-year payout will still be pretty bulky (another 21p per share dividend would still create a giant 6% yield, let’s not forget).

Direct Line’s not without risk, clearly, but given that cheap valuation, huge dividend yield, and resilience in tough conditions, I reckon the business is a great income share to load up on today.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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