Helios Underwriting — Capacity increase supports strong growth

Underwriting capacity is the lifeblood of Lloyd’s syndicates and of Helios as an aggregator of syndicate exposure. The capacity owned by syndicates or by Helios through its exposure to syndicates determines the level of premiums that can be written in a given year and, as a result, underwriting profit potential. The outlook for capacity growth at the end of H122 was limited due to slow working capital generation during the first half. Weak investment returns (which continued during the second half), the steep expected underwriting profile (weighted towards FY23 and FY24) and the impact of the war in Ukraine all contributed to this outlook. In our 29 September 2022 update note, we conservatively forecast capacity of £254.5m at the start of 2023. Subsequent developments have resulted in a large 17% beat relative to this forecast, with the company achieving £296.6m (of which £238.3m was retained capacity, net of reinsurance).

The 27% growth in capacity (39% growth on a retained basis) was possible because of two key developments, namely a successful capital raise in November 2023 and a historically high level of pre-emptions offered to Helios by its syndicates. The £12.5m in gross capital supported Helios’s LLV acquisitions in December 2022, as well as the additional capacity taken on during the Lloyd’s year-end auction.

Pre-emptions occur when Helios’s syndicates increase their own capacity levels (usually through acquiring capacity during the Lloyd’s auctions) and then offer Helios the opportunity to participate in this increase. There is no direct cost associated with Helios’s take-up of pre-emptions, although it must provide the regulatory capital or funds at Lloyd’s (FAL) to back this increase in capacity, which affects free working capital. Following three years of pre-emptions averaging £7.5m per year, Helios was offered and took up a historically high level of pre-emptions of £36m by the start of 2023, higher than the £21.7m it expected in September 2022 when it released H122 results. The high pre-emptions offered were thanks to healthy growth for many of Helios’s top-quartile syndicates on the back of a strong pricing environment and market discipline. Pre-emptions contributed 16% to capacity growth over the year and were valued at £12.4m, which will increase Helios’s weighted average value of capacity (WAV) at 31 December 2022, bolstering its balance sheet.

On 24 November 2022, Helios announced the successful raise of £12.5m in gross capital at a price of 156p/share, resulting in an 8m increase in shares in issue to 77.7m. The issue price was in line with the market closing price on 22 November 2022 and at a premium to NAV/share of 148.6p on 30 June 2022. Based on our calculations, the price of the raise (above NAV/share) resulted in zero dilution to FY23 earnings. However, it bolstered Helios’s free working capital and its ability to deploy capital into capacity growth.

In addition to the £36m that Helios added to its capacity at the start of 2023 through pre-emptions, it increased tenancy capacity by £38.9m net and added £5.7m through LLV acquisitions, offset by a £16.7m reduction as a result of the net disposal of capacity in the Lloyd’s auction.

Unlike normal underwriting capacity, tenancy capacity does not provide a permanent increase in Helios’s capacity and therefore does not allow it to participate in increased premium production for longer than the following 12 months. There is no direct cost associated with Helios’s acquisition of (temporary) tenancy capacity, although it must provide the regulatory capital (FAL) to back this increase in capacity, which affects free working capital. Unlike pre-emption capacity, tenancy capacity is not ascribed a value in the WAV and therefore has no immediate positive impact on Helios’s balance sheet. However, any underwriting profits earned on additional premiums backed by tenancy capacity (specifically in 2023 as it relates to the £38.9m that has been added) would add to earnings and benefit the company’s NAV. All things being equal, the addition of tenancy capacity will enhance Helios’s return on NAV (RONAV), which is demonstrated by our updated forecasts, discussed below.

On 29 December 2022, Helios announced the successful acquisition of three LLVs for a consideration of £5.7m, resulting in a £5.7m increase in capacity. The acquisitions were concluded at an average 11.7% discount to the Humphrey valuation (Humphrey & Co is an established firm that produces valuations on LLVs). These transactions were assumed to be balance sheet neutral with a £2.7m addition to WAV and a £3.0m addition to financial assets, offset by the £5.7m consideration.

On 10 January, Helios released its retained capacity update, which highlighted the 27% increase in gross capacity to £296.6m (39% increase in retained capacity to £238.3m) at the start of 2023. In addition to the pre-emptions, LLV acquisitions and tenancy capacity addition, the company reported a £16.7m net reduction in capacity due to the Lloyd’s capacity auction at the end of 2022.

The large 39% increase in retained capacity has increased Helios’s participation in future underwriting returns, which we forecast to improve strongly in FY23 and thereafter. Exhibit 1 shows the meaningful growth in retained capacity per issued Helios share over recent years and illustrates the company’s effective capital management notwithstanding the large increase in issued shares in FY21 and FY22.

An important enabler of the enhanced capacity at the start of 2023 was Helios’s decision to increase its excess of loss FAL facility (a risk transfer mechanism reducing the FAL that the company has to hold at Lloyd’s) from £6m to £27m at an additional cost of 9% per year, amortised over the first 24 months of an underwriting year. This increased cost was allowed for in our latest forecasts below from FY24.

In recent years, the meaningful increase in Helios’s capacity has been accompanied by active steps to manage and diversify the risks within its syndicate portfolio. The company has actively sought to broaden the portfolio away from natural catastrophe exposure, with large loss exposure reducing by c 5% at the start of 2023 thanks to exits from specific catastrophe syndicates (after a c 4% reduction in the prior year with the addition of Blenheim Syndicate 5886). Helios has also supported a number of new syndicates that bring non-correlated exposure to the portfolio by targeting business not naturally gravitating to Lloyd’s (eg gaining access the non-traditional Acrisure broker network). The company has also sought to enhance its ESG commitment by supporting tech-enabled underwriting opportunities in developing countries (eg the Click for Cover managing general underwriter, offering cyber cover to small businesses).

The improved diversification in its portfolio allows Helios to better manage its risk, to target sustained outperformance against the Lloyd’s market as a whole, which supports our optimistic outlook for profitability and shareholder returns over the coming years.

Two factors have weighed on Helios’s FY22 earnings expectations, resulting in a downgrade to our EPS in September 2022 from 7.2p/share to a loss of 1.1p/share. Firstly, weak investment returns on the back of rising yields affected mark-to-market fixed interest portfolios and continued in H222. We considered this in our September 2022 adjustment and made no further change. Secondly, the war in Ukraine affected the 2021 year of account (YOA) underwriting result. Claims expectations have deteriorated somewhat since the half year-end and we have increased our allowance for Ukraine (1% higher claims ratio at 60% for the 2021 YOA) and Hurricane Ian (1.5% higher claims ratio at 69.5%for the 2022 YOA). The net impact is a downgrade in FY22e EPS from a loss of 1.1p/share to a loss of 1.2p/share.

However, much higher capacity at the start of 2023 has resulted in a more optimistic outlook for premiums and underwriting results, as well as free working capital generation. On the back of this, we have increased our forecasts for the underwriting operating result by 20.5% for FY23 and 22.5% for FY24 (compared with a 27% increase in gross capacity and a 39% increase in retained capacity at the start of 2023). Against this, we have allowed for a number of offsetting factors, including:

The net impact is a broadly unchanged EPS forecast for FY23 (21.8p/share) and a 4% upgrade in FY24 EPS to 31.3p/share. Based on the observed Lloyd’s auction prices, we estimate a healthy increase in WAV over 2022 before revaluation. However, if we take into account elevated average auction prices in 2021 and relatively lower prices in 2022, this is likely to be largely offset by a negative revaluation. We therefore forecast largely flat WAV at £61m at 31 December 2022. As a result of this, as well as the increase in issued shares, our forecast NAV per share has been cut for FY22 to FY24, after which it reverts and surpasses our previous forecast levels with the impact of increased capacity offsetting the larger number of shares in issue. On the back of these forecast changes, we have lifted our forecast RONAV for FY24 from 15.7% to 17.1% (17.7% forecast for FY25), which positively affects our valuation.

Our base case valuation of 252p/share uses a 15.9% over-the-cycle RONAV, based on the average return forecast from FY23 to FY25. This is a 5% increase on our previous valuation of 240p/share, supported by a much higher capacity base from which to generate premium revenue and underwriting margin. The increase also benefited from a reduction in cost of equity from 10.5% to 9.8% on the back of lower observed risk-free rates (we are using 3.3% versus 4.0% before).

Our fair value for Helios is a 1.39x multiple of its FY23 forecast NAV of 180.7p/share and at a 58% premium to the current share price. The valuation is not well supported by expected FY22 EPS or dividends, but, once the effects of improved underwriting conditions start to emerge from FY23, the forward earnings multiple implied by our valuation is attractive at 11.5x and declines rapidly to 6.6x in FY25. Similarly, the dividend yield becomes more attractive from FY23.

While our valuation for Helios indicates a relative value on an implied forward earnings and NAV multiple basis, the company far underperforms the peer group on dividend yield. This is because Helios chooses to retain most of its earnings to fund capacity growth.