I’ve always like the insurance sector. It can be cyclical and a bit volatile, but for long-term investors I think its cash generation characteristics win through.
I tend to prefer those that offer life insurance, and currently hold Aviva shares, but I do rate general insurer Direct Line Insurance Group (LSE: DLG) highly.
The Direct Line share price today is the same as it was five years ago, and that’s disappointing. But it has been paying strongly progressive dividends which reached a yield of 6.6% last year, and the share price weakness puts it on what I see as a tempting valuation. Earnings are expected to fall this year, and I can’t help seeing a forward P/E of 12 as undemanding.
The first half, reported Wednesday, brought in a 10.8% drop in pre-tax profit, with EPS down 11.4% — but the dividend was lifted modestly, from 7p to 7.2p.
Motor
The weakness was largely down to tougher trading in motor insurance, which is under pressure, and the ending of the company’s partnerships with Sainsbury’s and Nationwide contributed. The division saw profit falling to £153.8m from the £239.5m recorded in the first half of the previous year. Motor insurance gross written premiums were down too.
Direct Line is investing in a new technology platform for its motor and home insurance businesses, and the roll-out of that is already underway. The firm says this will “allow us to offer more flexible products,” and coupled with the reduced costs that the firm is working on, I think we might see a better second half than expected.
Direct Line looks to be integrating its technological approach to its business well, and I see the current share price weakness as presenting a buying opportunity.
Comparison
Over the past few years, fellow FTSE 100 constituent Admiral (LSE: ADM) has followed pretty much the same up-and-down earnings pattern as Direct Line, though its shares trade on a higher valuation. Admiral has a market cap about 40% bigger, and its shares are on a forward P/E of 18 — 50% ahead of Direct Line’s.
And that’s after a weaker share price performance from Admiral, which has resulted in a five-year fall of 18%. Admiral dividend yields have been lower too — still healthy at 4.4% last year (and forecast at 5.4% this year), but that 6.6% yield from Direct Line was more impressive.
Admiral has lifted its dividend progressively, having almost doubled it in the four years from 2014 to 2018, and has a slightly unusual policy of paying only a modest ordinary dividend and then topping it up with special payments every year.
Flexibility
That might not give some investors the same confidence as a higher ordinary dividend, but I like the Admiral way of doing things. A higher ordinary dividend makes it seem like a much bigger failure if it needs to be cut — and that can delay dividend reductions when they really need to be made. The big insurers were overstretched during the financial crisis, and I can’t help thinking that an Admiral-style dividend policy would have led to earlier cuts which would have been less painful overall.
I see both these insurers as buys now, with Direct Line my better-value choice.