Robert Stephens, CFA, considers the recovery prospects of two out-of-favour FTSE 100 shares – insurer Direct Line and supermarket chain Morrisons.
While the FTSE 100 may have gained in popularity in the last few months, the valuations of a number of large-cap stocks have come under pressure. They could present buying opportunities for long-term investors – particularly in cases where their operational and financial performances have been strong.
Two companies that appear to fall into that category are insurance business Direct Line (LON:DLG) and retailer Morrisons (LON:MRW). Both stocks are now priced at a similar level to where they started the year, and could offer recovery potential after their recent declines in market value.
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Tough trading conditions have characterised the first part of 2019 for Direct Line. The motor insurance market has been particularly challenging, with market premiums failing to rise at the same pace as claims inflation.
In spite of this, the company is on track to meet its guidance for the full year. It is focusing on keeping costs down in order to maintain a combined operating ratio of between 93% and 95%.
It is also expected to deliver on its technology transformation programme, which will see it launch a new brand called Darwin that will target comparison sites. This is set to provide the opportunity to try out new ideas, and could make the business increasingly innovative.
With Direct Line’s share price having fallen by 15% since the start of April, it now has a forward P/E ratio of 10.4. Its dividend yield of 9.4% includes special dividends, which may be less reliable than ordinary dividends. However, its income appeal seems to be high having paid out 167p per share as dividends in the last five years.
Although there may be uncertainty ahead for the business as Brexit progresses and its changes to senior management positions take effect, Direct Line’s low valuation, innovative strategy and high yield suggest that it offers an improving investment outlook.
Trading conditions have also been tough for Morrisons. Even so, last week’s trading update showed that the company has now recorded four consecutive years of first-quarter like-for-like sales growth.
Its wholesale business has continued to make good progress, with strong sales increases being reported despite weak consumer confidence. The company’s focus on improving the customer experience appears to be increasing its competitive advantage, and may help it to ride out the current uncertainty facing the wider retail sector.
Online growth could play a major part in Morrisons’ medium-term future. It now has greater flexibility in its online operations, and is able to have more than one digital partner following an agreement to give up space at a new fulfilment centre to Ocado after its recent fire. This may provide an additional growth catalyst for Morrisons.
With the company successfully reducing its net debt levels and investing in its customer offering, it could outperform many of its rivals in what is set to be a challenging period for the supermarket industry. Trading on a forward P/E ratio of 14.5, it is hardly cheap. But its EPS growth forecast of 10% for the current year suggests that it has a bright future which could see it recover after a 10% share price fall in the last three months.