Direct Line rallies on Morgan Stanley upgrade

The bank said the company’s shift towards more own brands business and away from partnership business should lead to higher return on equity, greater customer retention and higher-quality earnings.

MS said that as commission costs decline and retention improves, the acquisition costs over the customer lifetime are lower, driving margins higher. It expects return on equity to rise from 16% in 2016 to 17.2% in 2019.

In addition, it highlighted Direct Line’s ongoing development and integration of IT infrastructure and said this was a key differentiating factor from other European insurers.

“Year to date, Direct Line has significantly underperformed listed peers, but we believe there is scope for dividend growth to follow the improvement in earnings, with continued special dividends and a gradual rise in the payout ratio over our forecast period.

“We also see earnings from prior year development declining relative to current year earnings, making reserve release sustainability less of a debate.”

At 0855 GMT, the shares were up 3.4% to 360.10p.