Helios Underwriting — Delivery into a strong underwriting cycle

We have flagged improved operating results for Helios since our February 2022 initiation and, while the FY23 results were very strong, they have not meaningfully shifted the needle in terms of our forecasts and valuation. In fact, we have reduced our EPS forecasts by 5.5% to 24.8p in FY24 and by 1.9% to 36.9p in FY25 due to higher operating expenses than we had expected. The Lloyd’s underwriting environment remains very healthy and provides strong support for our forecasts.

A key metric that demonstrates this is RoC, which is only determined once a YOA closes out after three years, with the latest close-out being for the 2021 YOA. Helios delivered a 6.8% RoC for the 2021 YOA, which compares to 3.6% for 2020, 3.3% for 2019 and negatives for the two years prior to that. The mid-point estimates (provided by Lloyd’s syndicates based on observed experience) are already pointing to an RoC in FY24 for the 2022 YOA of 8.1%, although we forecast a further improvement to 12.2%. Following the super start for the 2023 YOA (an RoC contribution in its first year of 2.5%, where negative RoCs are usually delivered), we forecast a top-of-the-cycle RoC for this YOA in FY25 of 17.1%. On the back of this, we forecast RoNAV of 18.9% in FY24 and 20.1% in FY25, including an allowance for the revaluation of on-balance-sheet capacity in line with expected pre-emptions (from existing syndicate participation). Without these revaluations (allowing for EPS impact only), the forecast returns are 12.6% in FY24 and 16.1% in FY25.

After FY25, the outlook becomes more uncertain and a downturn in the underwriting cycle becomes more likely. While it is possible to see an extended hard underwriting cycle, especially considering record premium increases experienced over recent years, high margins invite competition and increased capital allocation, and we have opted to allow for a soft landing from FY26 onwards. As such, we forecast a moderation for the 2024 YOA RoC to 13.3%, an increase in combined ratio from 89.2% in FY25 to 91.4% in FY26 and an EPS decline of 11.2% from 36.9p in FY25 to 32.7p. This manifests in a decline in RoNAV to 15.1% (or 12.5% without capacity revaluation).

Helios’s stated strategy before its CEO’s departure was predicated on increased participation in the current hard underwriting cycle by actively deploying capital into existing syndicate opportunities, seeking and promoting new syndicate opportunities and extracting additional value from its growing capacity. The latter included its ‘rental capacity’ initiative aimed at generating fee income from third parties (see our January update note) on its growing capacity. We had taken a wait-and-see approach in allowing for this in our forecasts, expecting more clarity following the FY23 results.

In its announcement of the departure of its CEO, Helios also indicated that it would not proceed with establishing a ‘follow-only’ syndicate at Lloyd’s, which was part of this third-party initiative. Its future strategy is still under review, but indications are that it will focus less on strong capacity growth and more on value extraction from the existing portfolio, with more liberal shareholder distributions through dividends and share buybacks. On 19 June, Helios announced a new share buyback programme of up to £3.7m. We expect Helios to leverage its strong Lloyd’s capacity position by employing the PEM initiative in maximising underwriting results, RoC delivery, EPS growth and RoNAV, included in our forecasts. However, we have moderated our capacity growth forecasts, especially as they relate to retained capacity, allowing for the increased utilisation of third-party capacity (‘rental capacity’ in addition to quota share reinsurance). We have also allowed for higher distributions (increased payout ratio, although this may take the form of share buybacks), to maintain an acceptable level of free working capital and in support of our RoNAV forecasts.

The soft landing we forecast in FY26 could be overly conservative if the hard underwriting cycle for Lloyd’s is extended and the PEM initiative is successful in extracting additional value from syndicates, but is increasingly unlikely to be bolstered by aggressive capacity accumulation. Helios is expected to review its stop loss and excess of loss reinsurance arrangements, which could result in future savings, not yet accounted for in our forecasts, but offering upside.

FY23 results deviated from our forecasts (see our April update note) in a number of key areas:

We have moderated our FY24 forecasts, with positive adjustments in a number of areas being offset by higher forecast expenses. The syndicate underwriting operating result forecast is largely unchanged at £37.4m, thanks to higher forecast investment income on financial assets offsetting a slightly higher combined ratio (90.4% vs 89.9% forecast previously). We have also allowed for a less extreme pre-acquisition impact due to a higher starting level of Lloyd’s capacity and lower capacity growth during the period than had previously been forecast.

We have forecast expenses based on the new split disclosed by the company. Stop-loss costs are forecast to almost double due to the large increase in capacity, but this is not out of line with our previous forecasts. We now forecast portfolio FAL financing separately and allow for a substantial increase from £3.1m to £7.8m, driven by the US$75m of seven-year unsecured debt (with a 9.5% coupon) raised in December 2023. This increase had been included in our previous forecasts.

On a combined basis, we have lifted our expense forecasts by £2.0m from £18.0m to £20.0m, with the increase largely relating to operating costs. We forecast clean (of portfolio FAL financing) operating costs of £7.2m, up from £6.8m in FY23, with the £0.8m in one-off costs in FY23 not expected to be repeated, but allowing for additional costs relating to the CEO transition. This represents a 4% increase in base costs and an increase in bonus costs commensurate with our forecast increase in operating profit.

The net result of our above forecast changes is a 5.5% reduction in EPS to 24.8p. We forecast NAV of 218.9p/share at the end of FY24, which implies a RoNAV of 18.9% for the year.

Our forecasts for FY25 are slightly lower from a revenue point of view (allowing for more modest capacity growth) and, with a slightly higher cost base (flat operating costs on FY24, with modest increases in stop loss and portfolio FAL financing costs), we have cut our EPS forecast by 1.9% to 36.9p. We forecast NAV of 248.6p and RoNAV of 20.1%.

Our FY26 forecasts conservatively allow for a turn in the underwriting cycle, which has a negative impact on our forecast revenue. We forecast an increase in combined ratio from 89.2% in FY25 to 91.4% in FY26, which results in an 11% decline in the underwriting operating result to £43.3m. After allowing for a continued increase in reinsurance income and investment income on FAL, offset by a continued increase in expenses (albeit allowing for only modest increases in stop loss and portfolio FAL financing costs), this results in EPS of 32.7p in FY26, down 11.2% on FY25. On the back of this lower forecast EPS, RoNAV for FY26 is forecast to moderate to 15.1%.

Our forecasts offer upside potential if Helios can reduce its stop loss and FAL financing costs, which is an area of increasing focus for the company.

Our base case valuation of 280p/share uses a 14.2% over-the-cycle RoNAV, which has been reduced from the 14.6% used in our previous notes. Our over-the-cycle RoNAV is based on the average RoNAV forecast over the next five years, which includes a turn in the cycle from FY26 and allows for 75% of capacity fund revaluations in its calculation (for conservatism).

At the same time, we have slightly increased our cost of equity from 10.3% to 10.6% based on a risk-free rate of 4.1% (up from 3.8%), a risk premium of 6.5% and a beta of 1x.

Our valuation uses a RoNAV versus price/NAV approach and has been determined with reference to the NAV/share disclosed as at 31 December 2023, which was 189p/share (compared to the 187p/share) used in our previous valuation.

The latest valuation of 280p/share is unchanged from our previous valuation (in April 2024), with the positive drivers of increased proximity to stronger cash flows, a higher NAV/share used for our calculation (based on actual FY23 delivery) and a more liberal distribution policy, offset by lower near-term forecasts, a slightly higher cost of equity and a slightly lower over-the-cycle RoNAV.

The valuation offers potential upside from the new share buyback programme announced on 19 June, as well as a longer-lasting hard underwriting cycle than allowed for in our soft landing forecast from FY26. Reductions in stop loss and portfolio FAL financing costs could offer further upside, which will become clearer as the company’s strategy develops.

Our fair value for Helios is at a 1.48x multiple of its FY23 NAV of 189p/share and at a 65% premium to the current share price. The valuation is well supported by expected FY24 EPS (P/E based on 280p/share valuation of 11.3x) and by dividends (5.1% dividend yield based on the 280p/share valuation), becoming even more attractive with reference to FY25 forecasts (valuation P/E multiple falling to 7.6x and valuation dividend yield rising to 10.1%).