Usually when top FTSE 100 stocks are trading at bargain valuations, there’s a good reason. Investors just aren’t that into them.
That doesn’t mean you should shun them yourself. Patient, long-term investors are happy to give embattled companies time to recover, especially if they have strong balance sheets and pay attractive dividends, as these two do.
Direct action
Direct Line Insurance Group (LSE: DLG) is a bit of a car crash, judged by its share price, which is down 15% over the last six months while long-term performance has also been weak. It’s a household name, so why the struggle?
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As a motor insurer, it operates in a highly competitive market. It has made the decision to shun price comparison sites, and only take direct custom. It’s a bold move that may help the group withstand the race to the bottom on premiums, but also means sacrificing business.
Gross written motor premiums fell by 2.2% in the first half, although they were offset by a rise in revenues from its commercial and rescue operations, while home held steady.
Direct Line suffered a 10.2% drop in first-half operating profit to £274.3m, although that beat consensus forecasts. The market response looks harsh, given that the £4.12bn group remains on course to hit its 2019 financial targets and has a proven track record of profitability.
Cheap and cheerful
Management did cut its special dividend from 15p to 8.3p in March but it still offers a whopping forecast yield of 9.6%. That is covered just once by earnings so isn’t entirely secure, but the group has a strong capital position with a solvency capital ratio of 180%. Better still, the Direct Line share price currently trades at just 10.7 times forward earnings, well below the FTSE 100 average of around 17 times.
Brexit hovers and earnings growth projections look unexciting, but if the dividend holds and you reinvest your payouts, you will double money in just over seven years, and can treat any share price growth as a bonus.
Tough viewing
My other bargain FTSE 100 pick is another household name, broadcasting group ITV (LSE: ITV). This has been through an even tougher time, down 20% over the past six months and almost 50% lower than it traded five years ago.
This has left the £4.33bn group trading at just 8.5 times forward earnings, making it even cheaper than Direct Line. Last month’s half-year results were “modestly better than expected”, with online revenues up 18% despite tough comparatives, while Love Island provided a “strong finish” to the half.
However, total external revenue fell 7% to £1.48bn, total advertising revenue fell 5% (while beating guidance) total ITV Studios revenue dropped 6% to £758m, although this was expected and deliveries are weighted to the second half.
ITV continues to deliver cost savings and its joint BBC venture Britbox is due to launch in the UK in Q4. The group also boasts a solid balance sheet, is delivering cost savings and has committed to a full-year dividend of at least 8p per share. The ITV share price now comes with a forecast yield of 7.6%, with cover of 1.6.
Direct Line and ITV could prove a winning high-income recovery play, if you give them time.
