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

Challenger Ltd (ASX: CGF), formerly known as Challenger Financial Services Group Limited, is in the provision of financial services and is managing $81 billion in assets as at 30 September 2018. The Company operates through three segments - Life, Funds Management, and Corporate and other. CGF’s 1Q19 performance update with Life net book growth of 3.1% and Annuity sales of about $1.2 billion highlighted a sound result. The group has extended its distribution capabilities with strong annuity partnerships, including the one with Netwealth, and these will support annuity sales growth going forward.


Financial Performance (Source: Company Reports and Thomson Reuters)

Strong first quarter of FY 19 Performance: For the first quarter of FY 19, the company has posted the second highest quarterly annuity sales on record with 7% increase in the total annuity sales to $1,171 million over prior corresponding period (pcp). There was a 21% rise in Australian annuity sales to $1,071 million on pcp. Primarily, the strong growth in annuity sales reflects the company’s successful strategy to expand its distribution and product offering. Moreover, during the first quarter of FY 19, the company has reported total Life book growth for the quarter of $425 million or 3.1%, which is on the back of both higher Australian annuity sales and the benefit of a lower maturity rate compared to the pcp. Total Life sales amounted to $1,566 million for the quarter and were in line with the pcp. This was owing to healthy growth in Australian annuity sales that were offset slightly by a lower contribution from MS Primary (Japanese) and institutional sales. MS Primary sales witnessed a rise of 22% on the June 2018 quarter, however sales were down 52% when looked against pcp. There was a 6% rise in Lifetime annuity sales to $222 million on the pcp, benefitting from confirmation of means testing treatment for lifetime income products and continued strong demand for CarePlus. Net Life annuity flows for the quarter rose by 5% at $370 million, on the pcp. Annuity book growth for the first quarter of FY 19 was about 3.2% of the opening FY19 Life annuity book.


Life annuity maturities (Source: Company Reports)

Expanding distribution reach: Challenger has planned to further expand its distribution reach, and CGF’s range of fixed-term and lifetime annuities will soon be available through the Netwealth platform. The company had launched Challenger annuities on BT Panorama in August 2018 and as per the company’s recent plans, Challenger annuities will be available via HUB24. Once live, more than 70% of Australian financial advisers will be able to access Challenger annuities through their preferred primary platform. Further, CGF has also announced plans to further expand its distribution by making its full range of annuities to be available on the fast-growing specialist Netwealth platform. This is the fifth retail platform that will launch CGF annuities, which reflects strong demand from the advisers to be able to easily include annuities in their clients’ portfolios. Moreover, this will also expand CGF’s distribution reach as Australian retirees look for reliable income streams. The platforms and leading superannuation funds are moving ahead of retirement income reforms planned to help provide secure income in retirement, by building retirement solutions that manage risks in retirement while maximizing income. This will lead to significant growth in annuity sales, and will position the company strongly for the future.

Funds Under Management Position: At the end of the first quarter of FY 19, Funds Management FUM was reported to be of the order of $78.2 billion, which is an increase of $0.3bn for the quarter or 14% higher than 12 months ago. FUM grew on the back of positive investment markets of $0.7 billion and was partially offset by net outflows of $0.4 billion. Fidante Partners’ FUM was at $59.5 billion and was broadly stable for the first quarter. Challenger Investment Partners’ FUM was $18.7 billion, which increased by $0.4 billion for the quarter.

Key Personnel Change: Brian Benari has decided to retire as Managing Director and Chief Executive Officer from the Challenger Board in January 2019 and will work with Mr Howes over a six month period to ensure a seamless transition. Meantime, CGF has appointed Richard Howes to succeed Mr Benari. He has been a founding member of Challenger's Asset and Liability Committee, and he continues to serve on this committee.

Update on the impact of the Government’s proposed Retirement Income Framework: CGF has provided the update on the impact of the Government’s proposed Retirement Income Framework. The company has welcomed the proposed framework and the Government’s commitment to progress the Retirement Income Framework for the improvement of the standard of living of retirees by developing the retirement phase of superannuation. In this framework, the Government has reaffirmed its commitment for the introduction of retirement income contracts that will require superannuation trustees to make a retirement income strategy for the members in place by 1 July 2020. The requirement for funds to offer members Comprehensive Income Products for Retirement (CIPRs) is planned to be extended to 1 July 2022, to enable funds get sufficient time for the implementation of suitable high quality products. By allowing additional time and increasing the threshold will ensure that the whole industry has the sufficient time and scope for the development of the right products to meet the requirements of their members. Due to the demand from the industry, the threshold superannuation balance requiring the offer of a CIPR is scheduled to increase from $50,000 to $100,000. The proposed framework announcement will not affect the legislation and regulations already in place to enable the development of a wider range of retirement income products, that include deferred lifetime annuities. As a result, test rules to support these new products are scheduled to come into effect on 1 July 2019.

Positive Prospects of the Industry: It is projected that the customer base will get bigger and bigger over the coming years in Australia as the number of people to retire, which means people aged over 65, is anticipated to grow by 40% over the next decade and by 70% over the next 20 years. Currently, 4 million of Australians are over the age of 65 years and 42% of retirees are on full age pension. If the company continues to hold its market share of annuities then it will cater to more and more people as many individuals look for a guaranteed source of income for their money. Further, the size of the annuities is expected to grow over time too. This is on back of rising wages of the people. The rise in wages leads to bigger super contributions, which means a bigger pool of assets that can be converted into annuities down the line. Compounding also grows the superannuation portfolio year after year. If super fund balances can continue to grow at 9% or 10% a year over the long-term then that’s more money to be turned into annuities. The mandatory 9.5% super contributions as per the law also makes Australia’s retirement system as one of the best in the world. Moreover, if the people will start investing into retirement plans, the company will be able to allocate more into fixed interest investments, that can offer guaranteed income and the pool of these investments will rise and could result in more annuities. Additionally, the next growth phase will comprise of $7.2 trillion super system by 2032 in which $2.1 trillion has been earmarked for retirement. Till then about 7 million of Australians will be over age 65, 30% of retirees will be on full age pension, there will be new lifetime products and means test rules and the industry evolving to 20-25% longevity allocation.


Outlook (Source: Company Reports)

Decent Outlook: For FY19, CGF is on track to achieve the normalised net profit before tax growth of between 8% and 12% on FY18. The company also remains committed to its 18% pre-tax normalised return on equity target. Normalised return on equity is expected to expand in FY19 after the deployment of higher levels of capital from the MS&AD equity placement in August 2017, however it is not expected to reach the 18% target in the FY19 year. Moreover, the company remains strongly capitalized. The capital intensity is expected to reduce further and the company targets normalised dividend payout ratio to be in the range of 45% to 50% of normalised NPAT.

Stock Recommendation: Meanwhile, CGF has fallen 19.34% in three months as on November 09, 2018 and is trading at a P/E of 18.22x. CGF is trading at $9.84, and has support at $9.18 and resistance at $11.58. CGF has made significant progress on a number of key growth initiatives that comprise of the program to expand Challenger’s distribution reach by making annuities available on platforms. In the past one year, Challenger’s annuities were launched on the BT Panorama platform and the company has made new arrangements to launch on Hub24 and Netwealth. Once complete, Challenger annuities will be available on the platforms and used by 70% of Australian financial advisers. At the end of the first (September) quarter, the total assets under management stood at $81 billion, which is a decent base. The group is expected to witness a single digit stock price upside in medium term given the scenario while CIPR related schedule may pose slight issues to margins. On the other hand, CGF is expected to get a boost from Australian sales on a continued basis. CGF expects pre-tax ROE to improve against that reported in FY18. Based on the foregoing, we give a “Buy” recommendation on the stock at the current price of $ 9.84.
 

CGF Daily Chart (Source: Thomson Reuters)

 
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