Shares in Admiral Group (LSE: ADM) fell by around 6% today, after the firm missed consensus earnings expectations with its first-half results, reporting post-tax profits of £144m, against expectations of £153m.
It’s the second sharp fall in recent months for Admiral, which warned in July that premiums in its UK business were expected to remain under pressure for at least another six months.
Admiral shares are now down by nearly 13% in one month, and have underperformed motor insurance peers Esure Group (LSE: ESUR) and Direct Line Insurance Group (LSE: DLG) so far this year.
Is Admiral’s weakness a buy signal, or is there better value elsewhere in this increasingly competitive sector?
Running the numbers
Let’s take a closer look at each firm’s valuation:
| Â | Admiral | Esure | Direct Line |
|---|---|---|---|
| Trailing P/E | 12.6 | 11.5 | 12.2 |
| 2014 forecast P/E | 13.4 | 11.6 | 12.7 |
| 2015 forecast P/E | 13.6 | 11.0 | 10.9 |
Esure and Direct Line look slightly cheaper than Admiral, but there’s not really a lot of difference.
What about dividend yield?
| Â | Admiral | Esure | Direct Line |
|---|---|---|---|
| Trailing yield | 7.2% | 7.1% | 10.8% |
| 2014 forecast yield | 7.3% | 6.6% | 6.5% |
| 2015 forecast yield | 7.2% | 7.0% | 6.3% |
The first point to note is how high these yields are.
I tend to view yields of more than 6% as risk factors, and in my view the big risk here is that each of these yields represents both ordinary and special dividends. Ordinary dividend payments are rarely cut, but special dividends are meant to be one-off payments.
My concern is that investors in these firms may have come to see their special payments as ordinary.
Although each firm currently has a policy of distributing excess capital to shareholders through special dividends, this may not always be possible — what yields would they offer based on ordinary dividends only?
| Â | Admiral | Esure | Direct Line |
|---|---|---|---|
| Trailing ordinary yield | 3.5% | 5.0% | 4.6% |
Stripping out each firm’s special dividends shows that Admiral’s ordinary yield is much lower than those of Esure and Direct Line.
Should you worry?
Premium income is falling at each of these firms, and this trend hasn’t yet bottomed out. In today’s results, Admiral CEO Henry Engelhardt told investors that “we have yet to see firm evidence of … a return to premium growth”.
Here’s how each firm’s premiums have fallen over the last year
| Â | Admiral | Esure | Direct Line |
|---|---|---|---|
| Gross written premiums, H1 2014 vs H1 2013 | -8.9% | -1.9% | -5.1% |
Source: company reports
Although each firm has managed to maintain or increase its profits through some combination of lower claims costs, cost cutting, and selling add-on services to customers, I’m still concerned that these firms’ special dividends could soon come under pressure.
After all, any company that can pay an annual yield of 7% to its shareholders clearly isn’t being squeezed all that hard.
My pick of these firms to buy today would be Direct Line, but I believe that income investors can do better in today’s market.