Company Overview: Challenger Limited (ASX: CGF) is engaged in the provision of annuity products and is one of the leading fund managers in Australia. It reports its businesses into two operating units of – Life: comprises of the Challenger Life Company Limited (CLC), and provides annuities and retirement income products; Funds Management: invests across varied asset classes including fixed income, commercial property and equity markets. It comprises two business divisions, Fidante Partners and CIP Asset Management (CIPAM).

CGF Details

Decent Increase in Assets Under Management On the Back of Net Flows: Challenger Limited (ASX: CGF) is engaged in the business of annuities and fund management. The market capitalisation of the company as on 07 June 2021, stood at ~$3.66 billion. The main objective of the company is to provide its customers with financial security for retirement. It has been investing in its distribution, product and marketing capabilities and diversifying its product offering and distribution channels. This has resulted in an improvement in the performance of the company during the H1FY21 and Q3FY21 period.

CGF seems to be well-positioned for continued growth aided by diversified revenue streams in the Life business and a differentiated Funds Management offering.

During Q3FY21, the company reported an improvement in the assets under management, which grew by ~8% to over $100 billion during the quarter. The growth was aided by an increase in Life annuity book and favourable market conditions leading to Funds Management net flows. There has been increased traction in sales in its institutional term annuity and Challenger Index Plus, reflecting CGF’s effort in building relationships with new institutional clients. The Funds Management grew by ~9% during the quarter and included ~$7 billion of net flows during the period.

Steady Cash Position (Source: Analysis by Kalkine Group)

Segment Performance: During Q3FY21, net flows in the Life segment stood at ~$1,377 million, which comprises of $879 million in annuity net flows, and Other Life net flows of $498 million. The total life sales grew by ~155% to $2,419 million when compared to the previous corresponding period. This was achieved on the back of higher annuity sales and higher Challenger Index Plus sales. Annuity sales increased by ~165% to $1,572 million, driven by decent growth in domestic term annuity sales and partly offset by moderation in sales from Japan. The Prescribed Capital Amount (PCA) ratio of the Life business stood at 1.56x as of 31 March 2021.

Funds Under Management (FUM) increased by ~9% during the quarter and stood at $99.7 billion. FUM of Fidante Partners was at $78.8 billion, depicting an increase of ~10% for the quarter and the FUM of CIP Asset Management was $20.9 billion, reflecting an increase of ~8% during the quarter on the back of an increase in funds managed on behalf of Life.

Q3FY21 Life and FUM Performance (Source: Company Reports)

Capital Notes Repurchase Update: On 25 May 2021, the company has announced that it has completed its repurchase of 197,308 Challenger Capital Notes that were offered by eligible holders of Challenger Capital Notes 1. The invitation for repurchase was announced on 27 April 2021. It has accepted the valid offers by participating holders of Challenger Capital Notes 1 for repurchase at a price of $102 per Challenger Capital Note 1.

Strategic Acquisition: The company has announced that it has entered into an agreement to acquire MyLifeMyFinance Limited (MLMF), which is an Australian-based customer savings and loans bank. The acquisition price is pegged at ~$35 million, and provides the company to expands its secure retirement offering.

Top 10 Shareholders: The top 10 shareholders together form around 42.68% of the total shareholding, while the top 4 constitute the maximum holding. Caledonia (Private) Investments Pty Limited and MS&AD Insurance Group Holdings, Inc. are holding a maximum stake in the company at 17.38% and 14.94%, respectively, as also highlighted in the chart below:

Top 10 Shareholders (Source: Analysis by Kalkine Group)

Key Metrics: The company reported an improvement in ROE at 6.6% in H1FY21, compared to 6% in H1FY20. There was also a slight uptick in the gross margin to 91.2% during the period. The ROIC of the company stood at 0.8% during the period. There was an uptick in the debt-to-equity ratio of the company to 2.10x in H1FY21, from a level of 1.90x in the previous corresponding period. It ended the period with a cash position of ~$774 million as of 31 December 2020, with a total long-term debt of ~$7,387 million during the period end.

Growth Profile and Profitability Metrics (Source: Analysis by Kalkine Group)

Key Risks: The company is exposed to a variety of risk which includes funding and liquidity risk, investment and pricing risk, counterparty risk, business risk, reputation risk, etc., to name a few. Its line of business is also exposed to the risks of volatility in the investment market and the impact of macro-economic events like the ongoing COVID-19 pandemic.

Outlook: The company has reaffirmed its FY21 normalised net profit before tax guidance levels and expects to it to be at the lower end of the $390 million and $440 million guidance range. It has reacted to the investment conditions by substantially adjusting its annuity pricing. It has a target range of 45% to 50% normalised dividend pay-out ratio. From the long term perspective, the Australian superannuation market looks attractive with long term drivers in place. The Australian superannuation market registered a CAGR of ~11% over the last 20 years, and assets are expected to increase from $2.9 trillion to $6.6 trillion over the next 15 years.

Valuation Methodology: P/BV Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation: As per a recent update, the company has become a substantial shareholder in ‘Keypath Education International Inc’ with a voting power of 5.87%. As per ASX, the stock of CGF is trading below its average 52-weeks’ levels of $3.550-$7.370. The stock of CGF gave a positive return of ~12.24% in the past one month and a positive return of ~6.28% in the past one year. We have valued the stock using a P/BV multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We believe that the company can trade at a slight discount to its peer median P/BV (NTM trading multiple), considering the impact of the COVID-19 pandemic on the economic environment and the presence of volatility in the sector. For this purpose, we have taken peers such as IOOF Holdings Ltd (ASX: IFL), AMP Ltd (ASX: AMP), Pendal Group Ltd (ASX: PDL), to name a few. Considering the expected upside in valuation and current trading levels, decent performance in Q3FY21, rise in assets under management, expected synergy from the acquisition of MyLifeMyFinance Limited and focus on revenue diversification, we recommend a ‘Buy’ rating on the stock at the current market price of $5.410, down by 0.185% as on June 07, 2021.

CGF Daily Technical Chart, Data Source: REFINITIV

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

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Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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