BUY HOLD SELL – Challenger (ASX: CGF)

In a slowing growth, high inflation, and turbulent macro environment it is difficult to pick stocks. One that has managed to weather those headwinds with relative grace for a few reasons is Challenger (CGF).

CGF is an Australian based investment management company with a vision to help its customers achieve financial security for their retirement. Its annuities business is well integrated into the Australian financial landscape. 91% of its revenue comes from its Life segment (annuities), which claims the title of Australia's largest provider of annuities. 9% of its revenue is attributed to its Funds Management segment which has more than $100bn under its stewardship. It also operates a banking segment which it acquired at the end of 2020 and is expected to start ramping up lending to SMEs and certain non-retail entities in the fourth quarter of 2022. Challenger recently upgraded profit guidance citing benefits from its diversification strategy which included a jump in institutional and retail annuity sales. Now sees FY22 normalised net profit before tax towards the upper end of its $430m to $480m guidance range. To put the upgrade into context, this time last year CGF actually downgraded guidance due to shrinking credit spreads. Exactly the opposite of what is happening now. The major tailwind for the business at the moment is the shift in monetary policy and the outlook for higher interest rates. The attractiveness of its annuity products improves in a higher interest rate environment as the yield they can offer on their annuity products also improves. On May 5, Challenger’s three-year term annuity will earn customers 3.75% guaranteed, which compares to 1.4% a year ago. The other slow-burn driver for the business is the aging population in Australia and Japan. Its partnership with MS Primary allows the firm to sell Australian and USD-denominated annuities in Japan. The ‘latest’ research from the ABS which is a little dated (8/05/2020) revealed 500,000 Australians intended to retire in the next five years and they all need some form of income. In Japan, which is described as having a ‘super aging’ population, that figure is much higher. Marcus Today Stock Box - Challenger CGF

Main observations

  • ROE of 9.1% is expected to remain relatively stable for the next few periods. Against its peers, Suncorp (SUN) sits on 7.2%.
  • EPS growth is anticipated to outpace revenue growth this year and for the foreseeable future.
  • CGF sits on a PE of 17.5x, SUN sits on 16.7x so it is slightly more expensive of the two.
  • A gross yield of 4.5% is solid but behind SUN which offers 7.2%. Both fully franked.

What are the risks?

Challenger makes the majority of its money by offering an income stream for retirees, talking their money, investing it, and achieving a greater rate of return than what they have to pay back as an annuity stream. The main risk is that because they guarantee a specific return, they must achieve higher investment returns or risk losing money given its liabilities are relatively fixed and fairly large. Any shortfalls have to be made by shareholders. The implication is that in times of hardship and low investment returns, there is a risk of capital raisings which can dilute shareholder equity, write-downs and capital erosion. Given its mandate and requirement for lower-risk assets, its portfolio is skewed to fixed-income investments.

What are the tailwinds? 

Several long-term tailwinds are helping guide the business to greener pastures. The biggest one is the higher interest rate environment as mentioned above. Widening credit spreads will also see a positive impact on future margins over the longer term.

What are the tailwinds - Challenger

The super system in Australia is also set to triple over the next two decades, with $70bn moving from accumulation to retirement each year. More Australians are retiring with more money and for longer and they all need income. There is also a proposal in Australia’s new retirement legislation that would require superannuation trustees to offer a comprehensive income product for retirement by the first of July this year. Some see that as a convenient reason Challenger could see a bump in annuity sales in the near term.  

Broker stuff

There was a consistent response from the brokers following CGF's third-quarter update with a NEUTRAL rating shining through as the preferred recommendation. A solid set of numbers and positive trends were noted by Morgans which retained its ADD recommendation. Target price increased 5.2% to 814c. Macquarie was pleased by the guidance upgrade and observed CGF will shortly move into corporate and SME lending which should support growth. The long-term growth thematic, combined with the capital benefits of the acquisition of the bank licence added to the attraction for Macquarie. Target cut 1.5% to 660c. Citi downgraded to NEUTRAL calling the share price reaction to the quarterly update overdone. Noted asset values in Life and Funds Management are down and could cause headwinds. UBS lifted its target price 14% to 730c on the back of higher margins and higher Life sales. Added the quarterly update helped de-risk the business well ahead of August results.

Technical view 

The share price is up more than 48% in the last 12 months, outperforming the ASX 200 which is down 1.9% over the same period. Challenger has responded well to recent updates which bodes well for its upcoming investor day on May 24th. RSI is in the middle of the range neither overbought nor oversold. Momentum has started to slow down, the MACD forest just holding above the signal line. A reading below the signal line can be interpreted as a bearish indicator but given the company’s leverage to the bigger macro-environment, it is more likely to be an opportunity than a warning. The bulls were able to convincingly break through the 700c level after the well-received third-quarter update. This will continue to be a key level for the share price in the near term. Technical view BUY HOLD SELL - CGF


Short interest isn’t at a level to be concerned about. Not many people would be looking to bet against a company with an earnings profile tied to higher interest rates right now. Shorting - Challenger


Nick Hamilton was appointed MD and CEO in December last year but has been with the business since 2015. He managed the funds management business through a period of exceptional growth and performance. A proven track record of leadership and driving innovation according to the Chairman.

Top Investors

Back in 2019 Challenger (CGF) expanded its strategic relationship with MS&AD to support its growth strategy in Australia and internationally and increased its stake to 15%. Athene, Apollo and Vanguard have significant positions. More buyers than sellers going off the position change over the last year. Table - Top Investors - CGF

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