Broker tips: Direct Line, Smiths Group

Analysts at Berenberg slightly lowered their target price on insurance firm Direct Line from 344p to 331p on Thursday, noting the group's transformation efforts were not without risk yet needed, in the medium-term, to offset the multiple headwinds that were looming ever closer on the horizon.

Berenberg said Direct Line's interim results painted a picture of solidity despite the backdrop of challenging market conditions, with the company remaining on track to meet its financial targets in the short-term.

However, the German bank noted that over the medium-term, reaching its targets would depend on the group's ongoing transformation efforts.

Direct Line now admits that it has been at a disadvantage in the price comparison channel, making it difficult to compete for profitability, something that was regularly denied by previous management. To correct those deficiencies, Direct Line began investing significantly in order to transform "virtually every IT platform" in its business, something Berenberg agreed was necessary.

However, Berenberg noted the process was "not free" and did not come without "significant execution risk", with a failure to execute successfully potentially making growth in its core businesses even harder to achieve.

"We project material earnings headwinds. These include lower reserve releases, higher attritional loss ratios, increasing amortisation charges and lower investment returns. To offset these headwinds, DLG will have to deliver on its change programme to produce a more-efficient business capable of competing profitability on price comparison websites," Berenberg added.

While Berenberg supported Direct Line's change initiatives, it kept its 'hold' recommendation despite recent share price weakness.

Medical devices and security scanner maker Smiths Group got a boost on Thursday as Goldman Sachs upped its stance on the shares to 'buy' from 'neutral', highlighting a defensive profile and improving free cash flow.

Goldman said Smiths' defensive revenue profile is attractive given the uncertain macroeconomic backdrop. It pointed out that aftermarket/consumables make up more than 50% of group revenue, while US dollar exposure is around 50% of group revenue.

"Further, we believe recent Detection order wins should help to underpin FY20 revenues, John Crane is exposed to more resilient downstream oil & gas opex, and Medical's growth trajectory should improve following increased investment," the bank said.

In addition, it argued that the removal of Smiths Group's pension overhang, which is now in surplus, and continuing portfolio simplification should support the company's re-rating.