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A Closer Look at Direct Line Insurance's Dividend Potential

LONDON -- Dividend income accounts for around two-thirds of total returns, the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of Direct Line Insurance Group  (LSE: DLG  ) and assessing whether the company is an appetizing pick for income investors.

How does Direct Line Insurance Group's dividend history stack up?

  2009 2010 2011 2012
FY Dividend Per Share - - - 8p
DPS Growth - - - -
Dividend Cover - - - 2.7x

Source: Digital Look.

Direct Line was listed on the London Stock Exchange in October, after Royal Bank of Scotland Group divested a 34.7% slice of the insurer. And the bank has since cut its stake by a further 15.3% in recent months. Direct Line thus cannot provide investors with a meaty track record with which to gauge future dividend potential.

What are Direct Line Insurance Group's dividends expected to do?

  2013 2014
FY Dividend Per Share 12.6p 14p
DPS Growth 57.5% 11.1%
Dividend Cover 1.5x 1.7x
Dividend Yield 6% 6.7%

Source: Digital Look.

Still, an encouraging long-term earnings outlook is expected to underpin surging dividend growth, at least over the medium term, even though coverage is predicted to dip below the safety benchmark of two times projected earnings. City forecasters anticipate earnings per share to dip 14% this year, before rebounding 25% higher in 2014.

The company announced in this month's interims that operating profit from continued operations rose 32.9% in quarter one to 107.5 million pounds, while its combined operating ratio fell to 98% from 104.5% in the corresponding 2011 quarter. However, gross written premiums slipped 4.5% to just over 1 billion pounds, illustrating rising competition across its key markets.

However, Direct Line has its fingers in many pies, with significant exposure to the home and motor insurance markets and rising activity in other areas such as pet and travel insurance. This gives the firm tremendous flexibility and removes the reliance upon one sole market, while an ongoing commitment to competitive pricing is also helping it effectively lock horns with its rivals.

How does Direct Line Insurance Group's dividend prospects rate against the competition?

  Prospective Dividend Yield Prospective P/E Ratio
Non-life Insurance 4.7% 10.7
FTSE 250 3% 18.9

Source: Digital Look.

Direct Line was recently trading on a P/E multiple of 11.4 for 2013, representing decent value compared with its FTSE 250 counterparts, although it does trade at a slight premium to its fellow non-life insurers. Still, the company offers a dividend yield some way north of that of its sector peers, and double that of the yield of Britain's 250 largest-quoted entities.

In my opinion, Direct Line is a promising stock market pick for those seeking heady dividend growth. Combined with its diversified operations at home, the firm is also making solid headway in the international markets of Germany and Italy, while its cost-stripping programme should also boost profits moving forwards. I believe the insurer is well placed to enjoy solid earnings growth and thus healthy dividend prospects.

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