ASX Dividend Stocks: Is Helia's 13% dividend yield too good to be true?

I'm on a mission to uncover some of the market's most compelling dividend-paying stocks. The aim is to provide readers with the key data and forecasts to make more informed decisions. Today, we're reviewing Australia's first lender mortgage insurance provider – Helia Group (ASX: HLI).

Helia Group currently tops Market Index's dividend yield scan, with a massive 13.1% yield. A double-digit percentage yield tends to raise some red flags but there are a few reasons why Helia may continue to pay market-leading dividends for years to come.

Key stats

Helia is a leading provider of Lenders Mortgage Insurance (LMI) in the Australian residential mortgage market. The company is an LMI provider to Commonwealth Bank of new high Loan to Value Ratio (LVR) residential mortgage loans, which represented approximately 53% of Helia's Gross Written Premium in FY23.

• Market cap: $1.25 billion

• Dividend yield: 13.1%

• Price-to-earnings ratio: 6.2

• 12-Month performance: +21%

Recent earnings

Helia's first-half results (the company reports according to the calendar year) flagged a steep year-on-year decline in earnings, mainly as a result of mark-to-market unrealised losses on its bond portfolio due to rising interest rates.

For context, it is common for LMIs like Helia to hold significant bond portfolios. These companies need to maintain substantial capital reserves to cover potential claims. Bonds are considered safe and liquid investments, which also provide a steady stream of income. However, when interest rates rise, the price of older, lower-yielding bonds fall to compensate for their relatively lower interest payments.

Despite the year-on-year decline, underlying EPS remained resilient and the company continued to raise its dividend. The key numbers for 1H24 include:

• Statutory net profit after tax down 34% to $97 million

• Underlying net profit after tax down 22% to $106.5 million

• Underlying diluted earnings per share down 12% to 35.8 cents

• Ordinary dividend per share up 7% to 15 cents

• Continued ongoing buy-back of up to $100 million (of which $92 is outstanding)

Analyst outlook

Macquarie upgraded their earnings outlook after Helia reported a 3Q24 trading update on 31 October 2024. The analysts raised their earnings estimates by +19%/+8%/+3% for FY24-26, "underpinned by negative claims in the short-term, but better investment returns and insurance revenues in future years."

Despite higher earnings expectations, a Neutral rating and $3.80 target price was retained. The target price represents -6.5% downside at the time of the report (31 October) and approximately -17% compared to current prices ($4.57). Another way to look at it is that the trading update was a significant re-rating catalyst that sent the stock up sharply higher (up 10.5% between 31 Oct and 7 Nov).

Ratings and target price aside, the analysts forecast the following numbers over the next three years.

Source: Macquarie Research October 2024

Interestingly, earnings are forecast to fall substantially over the next few years. While underlying NPAT is forecast to fall 58% between FY24-26, EPS is forecast to fall 44% – Likely reflecting expectations of further share buybacks.

In a significant development on June 19, 2024, Helia disclosed that Commonwealth Bank intends to open its LMI contract to competitive bidding. This is a big deal for Helia because CBA contract generated approximately 53% of Helia's GWP in FY23. The current contract expires on December 31, 2025, at which point other providers will have the opportunity to compete for this partnership. The FY24-26 earnings dip may represent the potential (or partial) loss of CBA-related earnings.

Well capitalised

One of the key things to note is Helia's prescribed capital amount (PCA) coverage ratio, a measure of capital adequacy of an insurance company. The company's 3Q24 trading update noted a PCA coverage ratio of 2.23x, well above its target range and APRA requirements.

"Helia is committed to deploying capital at attractive returns for shareholders and it is the Board’s objective to return to and then operate within the target range of 1.40 to 1.60 times PCA," the company noted in its trading update.

The company's half-year and full-year results provide more in-depth insights into the company's regulatory capital. The most recent 1H24 result noted "PCA coverage of 2.08x, representing $390 million of capital above the Board target range."

The bottom line

Helia presents a conflicting narrative. The company is well-capitalised and management have a clear focus on returning capital to shareholders via buybacks and special dividends. They clearly have the potential to do so based on their PCA position.

Helia has also benefited from rising house prices, which support negative claims. In simple terms:

• Higher house prices: Rising property values reduce how much the company needs to set aside (reserves) for potential claims.

• More loan cancellations: When property prices go up, borrowers are more likely to refinance their loans (either with a new lender or the same one), which leads to fewer claims.

On the flip side, house prices fell 0.1% in December, marking the first monthly fall in 22 months, according to Core Logic. Macquarie analysts also flagged that "underlying consumer conditions continue to slowly deteriorate as rates remain elevated." There is also the risk that a portion or the entirety of the CBA contract is lost or amended, which will have significant earnings implications.