Direct Line Group
Direct Line Group (DLG.L) operates in arguably the most competitive non-life insurance market in the Europe. The existence of “Price Comparison Websites” or PCWs, where consumers can compare auto insurance prices across different brands, intensifies competition. As a result, UK motor insurers are delivering pedestrian growth. So why are we even writing about this? (Direct Line share price is trading at a 5-year low!)
Direct Line is a UK retail and SME focused insurance company that offers car, van, landlord insurance etc. Its unique distribution strategy includes direct, PCWs, partnerships and brokers.
Unquestionably, Direct Line operates in a structurally mundane sector. The current valuation means its growth ambition is underappreciated by the market. On the contrary, we believe pockets of growth opportunities exist
Although DLG operates in a structurally mundane sector, opportunities for growth exist. At current valuation, the market is not pricing in this opportunity yet.
Direct Line Group is a UK focused insurance company with an appreciation for technology, powered by a motivated management team that continues to build on its strong franchise.
It offers an attractive dividend yield of 8% and has a track record of increasing base dividend for 8 consecutive years.
Direct Line Group is a BUY. It currently trades at an attractive 9.0x price-to-earnings (TTM) with a potential >10% capital return.
How do insurance companies make money?
3 Reasons why Direct Line Group is a Buy Today
New technology = new opportunities
DLG is a forward-looking insurance company that embraces the power of big-data, not just as a buzzword. Since its IPO in 2012, it has invested >£750m in IT, ~20% of its current market cap.
Today, access to in-vehicle data provides insurers with invaluable information throughout the entire value chain. Its partnerships with car manufacturers BMW, Volkswagen and Toyota provide precisely that opportunity. As a result, DLG can analyse drivers’ risk effectively and promote safer driving, which leads to more accurate pricing of risk, improving margins for the group.
Besides that, building advanced models to capture new risk groups, simplifying processes via cloud-based solutions and developing data-driven propositions are among the many tech initiatives DLG is investing to unlock further growth potential.
Effective management team
DLG understands just how inefficient the sector has been and put together an ambitious transformation plan last November. It seeks to continue to simply its businesses and develop a more agile platform to grow.
Under the leadership of CEO Penny James, DLG made significant progress in cost management. Right now, DLG has achieved half of its cost target set by 2021, having only announced the target last November.
A frequently overlooked aspect of the Group is DLG Auto Services. It is a network of repair centres, wholly owned by DLG. Repairing ~90k accident damaged vehicles every year, the repair centres enables DLG to build scale, more efficiently manage cost and hence boosting its margins.
Building blocks for franchise success
Many argue that price is the sole consideration when it comes to buying insurance. This isn’t the case for DLG, the #2 player in the industry with a market share of ~12%.
Founded in 1985 as Royal Bank of Scotland’s insurance division, DLG has delivered profitable growth ahead of competitors owing to its strong brand name and differentiated products.
To put this in perspective, in 2019, DLG increased prices by 3.1% (2019 presentation) vs the market of 2.7% despite fierce competition.
Direct Line shares trading at an attractive valuation
The COVID-19 pandemic provides a good entry for two reasons. Firstly, the stock is yielding at a juicy 8%. Secondly, as the UK government increasingly advises against non-essential travelling, claims frequencies are likely to fall given reduced vehicle usage.
In addition, DLG has paused its share buyback program of £150m (£29m completed) with the expectation of resuming in due course. This implies another 3% yield when buyback is resume, bringing the total yield to 11%!
DLG has consistently pursue a progressive dividend policy and have been growing base dividend with an annualised growth of 8%. It has indicated that to grow its dividend in-line with business growth.
In the short term, DLG is exposed to increased travel claims due to the pandemic. Furthermore, this situation may persist longer than expected, potentially derailing and delaying any additional capital return.
Adding to the challenge, DLG operates in an extremely competitive and mature market, which could hurt brand loyalty during a market downturn. Regulatory changes on pricing and whiplash reform could temporary offset its growth plans.
Technology investments aren’t always straightforward. A step in the right direction doesn’t mean a foolproof plan. For instance, DLG wrote off £56.9m off its assets as part of its investments that didn’t meet its standards in 2017.
A focused, tech-enabled high profitability UK insurance business, DLG currently trades at an attractive valuation, offering a dividend yield of 8%. Currently, Direct Line shares offer an excellent entry point!
The delivery of its business transformation set out in the November 2019 business plan is paramount. The new IT platforms that will be rolled out in 2021 provides more agile pricing and business acquisition.
DLG is no big name and often fly below the radar in the investment world, which is why we find it unappreciated by the market despite its strong fundamental.
A quality compounder, conservatively managed company with a proven track record of delivering, DLG a good fit for investors who are seeking stable and growing dividend with a hint of growth potential.
What do you think about the company, sector and our view?