Direct Line's shares fall as Macquarie cuts rating to 'underperform'

12th Jan 2017 09:49

(ShareCast News) - Direct Line Insurance Group's shares declined on Thursday after Macquarie Research downgraded the stock to 'underperform' from 'neutral' and cut the target price to 345p from 295p.The downgrade comes as the government is due on 31 January to announce a decision on the interest rate used to calculate discounts applied to personal injury compensation.The Chancellor is expected to lower the current Ogden discount rate of 2.5% which is considered by many to be too high as it penalises claimants.Macquarie said it understands Direct Line carries a margin covering the cost of a 100 basis reduction in the rate to 1.5%."However, we expect the Lord Chancellor to set the rate between 1% and 1.5%," Macquarie said."Thus if the rate falls to below 1.5% then Direct Line's reserves may require strengthening."Macquarie predicts the new rate will cost the company £90m, in excess of the reserve margin the bank expects it currently holds.More importantly, the use of this margin in large bodily injury reserves will mean reduced reserve releases in the future, the bank added."Currently we expect that Direct Line has benefitted from releasing the excess margin between 1.5% and 2.5% when a claim is settled. This will potentially not be available in the future."Direct Line is "especially sensitive" to changes in reserve releases as the group depends on this source of earnings for 70% of its operating profits.Macquarie's earnings forecasts for the company are 16% below consensus in 2017 and 26% below consensus in 2018. The bank expects consensus forecasts to fall should the discount rate reduce."With a negative catalyst looming for Direct Line, we expect Direct Line to underperform the wider non-life insurance sector at least until the new Ogden discount rate is announced," the bank said."As such, we reduce our price target from 345p to 295p, as we factor in the increased uncertainty into our valuation through a higher cost of equity."Shares fell 1.28% to 347.70p at 1036 GMT.