Morningstar | Direct Line 1H 2018: Shares Overvalued; Still Have Major Concerns on Business Model
Direct Line reported first-half 2018 results that were ahead of our expectations. We still don't like the business model, but we accept that our previous near-term EPS estimate was slightly too conservative. We are therefore revising our fair value estimate up to GBX 260 from GBX 240 per share, but we maintain our no-moat and stable trend ratings.Gross written premiums are down 5% on the comparable, as the business lost home partnerships with Nationwide and Sainsbury's. Stripping these out, premium was up half a percent. Own brands are better, and this is where the business should focus, at just over 3% growth. This better balance has led to over 200 basis points of improvement in the commission ratio.
We are far less interested in solvency for these short-term businesses, but for the sake of completeness, Direct Line reported solvency of 169%.
While there are rational reasons for the decline in operating profit from GBP 360 million to GBP 303 million over comparable periods, we still find this business model very risky. First-half 2018 incorporated an additional GBP 65 million from weather-related events, but we see absolutely no favourable competitive positioning within these businesses.
The generic U.K. home and motor personal insurance market is highly commoditised, with customer choices driven by price. There is no loyalty in this market, and there are no real switching costs of value. Contracts are short-term, and underwriting standards are widely known. Adding fuel to our concerns, we are apprehensive about the longevity and competitive positioning for underlying businesses utilising price-comparison websites, which significantly increase price transparency and price competition. There has been a flurry of new entrants in this space in recent years, and we do not like the reliance on ancillary services that PCWs have created.
Direct Line Insurance Group is a personal and small business general insurer in the U.K. Co.'s principal activity is managing its investments in subsidiaries, providing loans to those subsidiaries, raising funds, and the receipt and payment of dividends. Co.'s segments are Motor, which consists of personal motor insurance together with the associated legal protection cover; Home, which consists of home insurance together with associated legal protection cover; Rescue and other personal lines, which consists of rescue products, and other personal lines insurance, including travel, pet and creditor; and Commercial, which consists of commercial insurance for small and medium-size entities.
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