Direct Line Insurance Group PLC (LON:DLG) and Esure Group PLC (LON:ESUR) slumped as Barclays Capital downgraded the stocks, citing a soft market in UK motor insurance.
In a note on the sector, Barclays said generous dividend yields of 6-8% are currently the biggest argument in favour of UK motor insurers.
But shareholder rewards are directly linked to earnings, meaning lower earnings would lead to lower dividends.
Insurers’ earnings could take a hit from further pricing declines as a result of potential whiplash reform and changes to the so-called Ogden discount rate, which is used to calculate compensation payments to accident victims.
“While the initial reduction in the Ogden discount rate led to c12% price increases, the partial reversal in Ogden and the potential for whiplash reform has resulted in pricing falling 8-9% from the peak,” Barclays said.
It added: “We expect management teams to have more cautious guidance at 1H18 results and we factor in pricing of -3% for 2018 and flat for 2019, leading to 1-9% EPS (earnings per share) cuts for 2018-2020.”
Barclays cuts earnings estimates for Direct Line
For Direct Line, Barclays expects the consensus forecast for first half EPS to be cut, putting the dividend at risk. The bank lowered its own EPS estimate for the 2018 fiscal year by 10.8% to 28.9p.
Barclays cut its rating on the stock to ‘equal weight’ from ‘underweight’ and lowered its target price to 357p from 420p.
“In our view, Direct Line is well positioned for the current soft market environment through its diversification and prudent underwriting approach, as well as balance sheet reserves that should allow further reserve releases,” it said.
“However, as the most liquid stock in a sector dominated by a negative top-down view at present, Direct Line may find itself in an unfavourable position – despite defensive characteristics and attractive yield, investors either don’t have to own any of the motor insurers, or use DLG as an instrument to short the theme; therefore, we downgrade to equal weight.”
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Shares in Direct Line fell 2.7% to 336p in morning trading.
Esure 'has highest sensitivity to falling prices'
Barclays downgraded Esure to ‘underweight’ from ‘equal weight’ and slashed its target price to 220p from 264p, saying the company is the most vulnerable to falling prices.
The bank noted that Esure is the fastest growing motor insurer at the moment, having increased gross written premiums by 18% in the first quarter, including 21% in the motor segment, and grew policies by 17%.
Esure aggressively increased share through price competition, according to insurance peers and independent surveys, but management has said its new customer acquisition is the result of footprint expansion programs that are accretive to underwriting profitability.
“We believe aggressive growth in a soft market environment increases risks of misinterpreting claims inflation trends, although for the past three years Esure has demonstrated an improving loss ratio,” Barclays said.
“In this note we change our rating to ‘underweight’ – our analysis shows Esure has highest sensitivity to falling prices because it has the highest combined ratio among our coverage.”
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Barclays reduced its forecast for 2018 EPS by 3.5% to 19.4p.
Shares in Esure dropped 4.6% to 204p.