Company Overview: Challenger Limited is an Australia-based investment management company. The Company operates through two segments: Life and Funds Management (FM). The Life segment includes Challenger Life Company (CLC), which provides annuities and guaranteed retirement income products, and Accurium Pty Limited, which provides self-managed superannuation fund actuarial certificates. It distributes products under the Life segment through independent financial advisors and financial advisors that are part of hubs. The FM includes Fidante Partners and Challenger Investment Partners (CIP). Fidante Partners encompasses a range of associate investments in boutique investment managers. Fidante Partners provides administration and distribution services to the boutiques and shares in the profits of these businesses. CIP develops and manages assets under the Company's brand for CLC and third-party institutional investors. The investments managed by CIP include in fixed income and commercial property.
 

CGF Details

Well-Positioned to Capture Opportunities: Challenger Limited (ASX: CGF) is a leading annuity provider and one of the fastest-growing fund managers. The company focuses on expanding into international markets. As on October 14, 2019, the market capitalisation of Challenger Limited stood at ~A$4.2 billion. It released its results for the year ended June 30, 2019 (or FY19), wherein the group’s assets under management amounted to $81.8 billion, reflecting a rise of 1% on a YoY basis. Amidst the challenging operating environment, the company managed to post steady normalised earnings that highlight the resilience of its business. Its market leading brand, diverse distribution channels and compelling product offering support the performance. The company continued to attract robust retail inflows in funds management and life, despite retail flows across the sector were at record lows in the last year. In life business, domestic sales were down marginally, with lower sales from major hubs offset by stronger sales by independent financial advisers. Between FY15- FY19, the company’s top line has witnessed a CAGR growth of 8.87% and, therefore, it reflects that CGF is possessing decent capabilities to garner revenues. The capital position remained robust, with the Prescribed Capital Amount (PCA) ratio of 1.53x, which is towards the top end of the target range of 1.3x to 1.6x. These types of results reflect the resilience of business amidst challenges in the operating environment because of significant disruption in the advice industry. The company’s top management stated that CGF is well-positioned when it comes to capturing the growth opportunities in life and funds management businesses, and there are expectations that superannuation industry assets might double in the span of upcoming 10 years.

There are expectations that the company’s capabilities to generate revenues and build its cash levels might act as long-term tailwinds. Additionally, the decent base of fundamentals and the focus towards providing income to its shareholders might attract the attention of the market participants. 
 

CLC Regulatory Capital (Source: Company Reports)

Top 10 Shareholders: The following table provides a broader overview of the top 10 shareholders in Challenger Limited:

Top 10 Shareholders (Source: Thomson Reuters)

Key Metrics: The company’s gross margin stood at 74.1% in FY19, which is higher than the industry median of 67.2%. During the same period, CGF’s net and EBITDA margin stood at 13.1% and 18.4%, respectively. The company’s Debt/Equity ratio stood at 1.97x in FY19, which is lower than the industry median of 2.12x and, therefore, it can be said that CGF’s balance sheet is less leveraged as compared to the broader industry. Generally, a less leveraged balance sheet reflects stability and, as a result, the company could focus on its growth objectives. Also, in this scenario, the company’s commitments are lesser, therefore, it can make deployments towards growth prospects. The company has managed to maintain a robust capital position, with $1.5 billion of the excess regulatory capital and cash, which implies an increase of $0.1 billion for the year. It was further added that Challenger Life Company’s prescribed capital amount (or PCA) ratio stood at 1.53 times, which is towards the top end of the company’s target range that is 1.3-1.6 times the minimum amount set by APRA. The robust capital position provides support for the future growth prospects in Challenger’s annuity book, and it also implies that business is well-positioned.
 

Key Metrics (Source: Thomson Reuters)

Appointment of Chief Executive Funds Management: Challenger Limited made an announcement about the appointment of Nick Hamilton as the Chief Executive, Funds Management, effective from September 23, 2019. This comes after an extensive internal and external search in order to replace Mr Ian Saines, who disclosed his intention to retire in the month of June. The Managing Director and Chief Executive Officer (or CEO) of Challenger Limited named Richard Howes reflected optimistic views on this and stated that Nick happens to be a renowned named when it comes to funds management industry, and he brings over 20 years’ experience gained throughout Australian and international markets.

Retirement of Leon Zwier: The Chairman of Challenger Limited named Peter Polson made an announcement that Mr Leon Zwier would be retiring from the Board of Challenger Limited. Additionally, it was stated that he would not be standing for re-election as Director at the AGM on October 31, 2019. In the span of the past 2 years, the Board witnessed a process of renewal in order to ensure that the company possesses the right mix of knowledge, skills as well as experience.

Appointment of MS&AD Representative to CGF’s Board: CGF’s Chairman named Peter Polson made an announcement about the appointment of Mr Masahiko Kobayashi as Non-Executive Director. The appointment comes after an expanded strategic relationship with MS&AD Insurance Group Holdings Inc. As part of a strategic relationship, MS&AD has increased Challenger shareholding to more than 15% of the issued capital and Challenger Limited started reinsurance of US dollar denominated annuities issued by Mitsui Sumitomo Primary Life Insurance Company Limited (MS Primary).

Stability Witnessed in Full-Year Dividends: Challenger’s capital position is managed at both the group and the prudentially-regulated CLC level, with the objective of maintaining the financial stability of the group and CLC ( Challenger Life Company Limited) and, at the same time, ensuring that shareholders earn an appropriate risk-adjusted return. The Board aims to dividend pay-out ratio in the ambit of 45%- 50% of the normalised net profit after tax. The dividend pay-out ratio for FY19 stood at 54.2% as compared to FY18 figure of 52.1%. The pay-out ratio is above the target pay-out ratio, which implies the resilience of the business and robust capital position. The company’s full-year dividend was stable as compared to FY18, and the figure stood at 35.5 cents per share (fully franked). Between FY15- FY19, total dividends per share (cents) have witnessed an increase from 30 cents to 35.5 cents and, therefore, it can be said that the company is possessing a decent income base to its shareholders. During the same time span, the company’s dividend pay-out ratio – normalised profit (%) has been improved from 49% to 54.2%.
 

Key Capital Metrics (Source: Company Reports)

What to Expect from CGF Moving Forward: While performance in FY19 was impacted by the disruption throughout the Australian wealth industry, the company’s business happens to be in good shape in order to navigate the current operating environment. Also, it is well-placed to tap the opportunities as and when they emerge. The company has robust product offerings, positive retirement market demographics, along with highly efficient operations. However, Challenger Limited is facing some kind of short-term challenges from the financial advice market disruption and higher market volatility. The company’s priorities primarily include improving the adviser experience, leveraging MS&AD strategic relationship and maintaining financial discipline along with the robust capital position. The following image provides a clearer picture of the company’s priorities:


Priorities (Source: Company Reports)

For 2020, the company has been targeting normalised net profit before tax in the range of $500 million- $550 million. Also, the company’s normalised cost to income ratio is expected to be above medium-term range, which is 30% – 34% in 2020 because of higher spend in order to help growth initiatives in distribution, product and marketing. CGF revised the target of RoE, and it is aiming normalised RoE of RBA cash rate plus 14% (pre-tax). Considering resilience and capital strength, there are expectations that CGF would be maintaining the same annual dividend amounting to 35.5 cents per share in 2020. This would be resulting in a normalised dividend payout ratio of above the target payout ratio, which is 45%–50% of the normalised profit.


Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodologies:

Method 1: P/BV- Based Valuation

P/BV- based Valuation (Source: Thomson Reuters), *NTM: Next Twelve Months

Method 2: PE- Based Valuation

PE- based Valuation (Source: Thomson Reuters), *NTM: Next Twelve Months

Note: All forecasted figures and peers have been taken from Thomson Reuters

Stock Recommendation: The stock of CGF has witnessed a fall of 9.97% in the span of previous six months, while on a YTD basis, there has been a fall of 24.86%. The 52-week trading range of the stock stands at $6.220 to $11.62 and currently, the stock is trading at the lower band of its 52-week trading range with reasonable PE multiple of 13.48x, proffering a decent opportunity for accumulation. CGF recently made an announcement that Dividend Reinvestment Plan (or DRP) issue price with regards to the final 2019 dividend is $7.0372 per share. It was further stated that DRP issue price reflects an average of the daily volume weighted average share prices for 10 trading days from September 4, 2019, to September 17, 2019. Between FY15- FY19, the company’s cash receipts witnessed a CAGR growth of 4.86% and, therefore, it can be said that CGF is possessing decent capabilities to build cash levels. There are expectations that the company’s capabilities to generate revenues and build cash levels might support CGF’s long-term growth prospects. Considering the aforesaid facts, business prospects, and current trading levels, we have valued the stock using two relative valuation methods, i.e., P/E and P/BV multiples, and arrived at a target price of high single-digit growth (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of A$6.940 per share (up 1.166% on 14 October 2019).

 
CGF Daily Technical Chart (Source: Thomson Reuters)

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