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One look at the share price chart of FTSE 250 insurer Direct Line (LSE: DLG) over the past few years is enough to make me shudder as an investor.
Direct Line is a well-known financial services brand that benefitted from decades of advertising spend. Until recently it was routinely making hundreds of millions of pounds each year in profit and paying out big dividends.
Given that it now has a market capitalisation of just over £2bn, could this be a bargain for my portfolio?
Possible recovery play
The main reason for Direct Line’s poor performance this year was its announcement in January that it was axing its previously juicy dividend. Business was tough, it was explained. There has been a stream of explanations this year as to why, from storm damage payout costs to pricing competition.
But with its experience, customer base, and brand, could Direct Line recover its former business standing and see its share price recover too?
One difficulty with this sort of recovery thinking is that often, when a business disappoints shareholders as Direct Line did in January, it is the culmination of many problems, not just one. As Warren Buffett says, “there’s never just one cockroach in the kitchen”.
Could that be the case here?
The company appointed a new chief executive this year but widespread cultural change tends to be slow work. Direct Line’s long steady share price decline over the course of many years reflects deep-rooted investor concern about its business model.
Blaming factors seasonal storms strikes me as odd. That is basically the bread and butter of the insurance industry and rivals like did not seem to struggle with winter storms in the same way as Direct Line.
The company announced this week that business remains tough, with fewer policies in force than a year earlier. It added that further adverse developments in claims from 2022 and this year “is expected to put pressure on earnings in 2023 including from prior-year reserve releases”. That is a clear risk to profitability, even after the FTSE 250 company reported a loss last year.
That was acknowledged by the chief executive, who said that the 2023 earnings outlook “continues to be challenging”.
But home, motor, and general insurance can be a very profitable business, as Direct Line has often demonstrated in the past. A strong brand like it has can help bring in customers cost-effectively, while disciplined underwriting can help profits. Direct Line has long underwriting experience.
If it simply gets the basics right, Direct Line has a strong foundation on which to recover. It still has over 9m policies in force, after all.
Restoring business performance and bringing back the dividend could see Direct Line shares come back with a vengeance, I reckon.
But is all the bad news out?
The latest trading statement clearly flagged ongoing risks to earnings.
Additionally, I still do not fully understand why Direct Line was so hard hit last year by factors that ought also to have affected competitors.
My concern is that the business needs a lot of fixing. That could take time and weigh on investor sentiment. For now, I will not be adding Direct Line to my FTSE 250 portfolio.