Right now I’m looking at some of the most popular companies in the FTSE 100 to try and establish whether or not they have the potential to push profits up to levels not seen in the last few years.
Today I’m looking at Direct Line Insurance Group PLC (LSE: DLG) (NASDAQOTH: DIISF.US) — the company behind Churchill and roadside recovery organisation Green Flag, as well as the main Direct Line brand — to ascertain if it can make £1bn in profit.
Have we been here before?
A great place to start assessing whether or not Direct Line can make £1bn in profit is to look at the company’s historic performance. Unfortunately, Direct Line has never been able to make £1bn and unless the company can triple, or even quadruple in size over the next few years, it is going to struggle to reach this target.
Indeed, Direct Line’s net profit margin has averaged 5% during the past four years, based on this, I believe that Direct Line would have to achieve sales of £20bn to make net profit of £1bn. Sadly, Direct Line only reported sales of £3.9bn during 2013, a fall of 4% from 2012.
But what about the future?
As mentioned above, Direct Line would have to quadruple revenue in order to reach my profit target based on historic profit margin figures.
However, it is unlikely that Direct Line will be able to achieve this growth or profitability since the company struggles to compete within the UK’s highly competitive insurance industry, where aggressive price wars have led to premium deflation. Essentially, this means that the average insurance premium consumers are being asked to pay is declining as companies undercut each other to try and drive sales — although the volume of claims has not declined.
In addition, there are a number of other factors working against Direct Line. For example, Direct Line writes 85% of its business within the UK, so the company is highly dependent upon the health of the UK economy. The company has set aside £100m to cover weather-related claims for this year.
What’s more, the motor insurance industry remains under investigation by the Competition Commission, which has received complaints from consumer watchdogs that inefficient competition within the industry was increasing motor insurance premiums for customers.
Finally, Direct Line relies heavily upon the performance of its investment portfolio to bolster returns. Indeed, as the stock market has surged higher over the past few years, Direct Line has reaped the benefits. Still, some City analysts believe that the market’s winning streak could be coming to an end, which would dent Direct Line’s profitability.
Actually, it would appear that this downbeat outlook has been factored into current City estimates for Direct Line’s performance during the next two years. Specifically, City analysts currently predict that Direct Line’s earnings per share will remain constant until 2015.
Foolish summary
So overall, I feel that Direct Line cannot make £1bn profit.