Embattled insurer Direct Line is striving to restore credibility with the market. The £520 million sale of its brokered commercial business will repair a balance sheet, but the incoming boss, Adam Winslow, will need to prove that he has the stomach to push pricing up if inflation proves more stubborn than anticipated.
Offloading this business to the parent company of rival RSA will unlock about £270 million in capital, £170 million of which will be freed-up if shareholders approve the deal before the middle of December.
No more disposals are needed, says Jon Greenwood, the acting chief executive. That is fair enough — the sale would provide a crucial 45 percentage point boost in the Solvency II ratio to 192 per cent, above the top-end of a target range of 140 to 180 per cent.
Without it, efforts to rebuild capital levels would amount to slow progress. A failure to increase premiums in the face of elevated rates of claims inflation has hammered underwriting profitability. In the first six months of the year it made a pre-tax loss of £76.3 million, well above the £11.1 million it suffered over the same period last year.
Earlier this year the bill for weather-related claims was double what was expected, proving the tipping point for Penny James, the former chief executive, who left shortly after. Now its motor business is the issue. The division’s combined operating ratio, a measure of underwriting profitability, worsened to almost 126 per cent. Anything above 100 per cent represents a loss.
Direct Line had underestimated the pace of claims inflation and just how stubborn higher repair parts and labour costs would be. Prices for average motor premiums climbed by 19 per cent in the first six months of the year — 25 per cent for renewals.
That cost the insurer customers, which declined by 4 per cent in motor, alongside a 1.5 per cent fall in home policies. Motor claims inflation is set to be in the high single digits this year as labour costs prove stubborn despite the price of second-hand cars cooling. Direct Line may have to sacrifice policy numbers for a while longer.
The group is now writing profitable motor business, according to Greenwood, equivalent to a 10 per cent net margin that puts the business back generating capital. But the impact of previous pricing decisions will not fully work through until 2025. Analysts think pre-tax profits next year will improve to £278 million, about half the pre-pandemic level. Even after a 16 per cent bump in the share price on the back of the brokered commercial sale, the shares trade at a marginal discount to its forecast book value in 12 months’ time, a steep discount to Admiral at 6.8. Prudent reserving is one reason for the latter’s premium. Pricing missteps and persistent inflation will curtail Direct Line’s ability to release reserves.
Regulatory matters could yet deliver a surprise. It is undertaking two reviews for past mistakes. One relates to the way it implemented new rules intended to prevent insurers charging existing customers higher premiums for renewed motor and home insurance than equivalent new customers. The second goes back five years, where it underpaid some claims from customers whose cars were written off. The estimated combined cost is £70 million.
Securing the sale of the brokered commercial will meet one condition for the reinstatement of dividends. The second is returning the motor business to generating capital organically. Analysts think a 15.1p a share payment might be possible at final results. But coming good on the latter will depend on Direct Line demonstrating that it can maintain a grip on premiums.
ADVICE
Hold
WHY
A better capital position and weighty premium increases could help improve profitability.
Currys
The Indian summer makes Christmas feel like an age away, but for retailers like Currys the peak trading season will prove a vital gauge of whether spending on big-ticket items is set for a rebound.
The most recent sales figures don’t push the dial firmly enough. Like-for-like sales in the 17 weeks to the end of August declined 4 per cent. Admittedly that was better than the 7 per cent fall recorded over the past financial year.
Cost of living pressures are one thing, but some of Currys troubles are self-inflicted. Underestimating the competitive challenges in the Nordics has cost the electricals retailer dear. Like-for-like sales fell 8 per cent in the most recent 17 weeks. In the UK and Ireland, underlying sales fell back another 2 per cent.
Gross margins have improved in both regions, management says, but no timeline has been reinstated for hitting an adjusted operating margin target of 3 per cent, which had been set for 2025.
November’s Black Friday sales and Christmas will be a better indication of whether the market is improving or if aggressive discounting is set to make a return. Cash burn last year tipped the group into a £97 million net debt position for the first time since 2020. Alex Baldock, Currys boss, is in cash preservation mode, aiming to cut capital expenditure by about a quarter this year to £80 million, which would take the two-year reduction to more than a third. The final dividend was also scrapped and it secured covenant relaxations until October next year.
The Greek business, which grew sales 3 per cent in the latest period, is up for review. A sale would provide a helpful infusion of cash.
The question is whether cost-cutting efforts will go far enough to offset sickly sales. Analysts have forecast another decline in adjusted pre-tax profits this year to £102 million, down from £119 million last year. After including impairment charges taken against the value of its assets, last year’s pre-tax loss amounted to £450 million.
Investor confidence in Currys’ earnings prospects is close to the lowest in at least ten years. The market is right to be sceptical that the retailer has done enough to engineer a turnaround.
ADVICE
Avoid
WHY
Cost cuts may not prove enough to offset weak sales.
