Challenger (CGF) has renewed its focus on margins, while expounding details on the expected benefits of the company’s platform as it is rolled out to industry funds and to Colonial First State. Morgan Stanley believes the growth options demand patience. While awaiting anticipated government support for the recommendations from the Financial Services Inquiry, the broker notes Challenger is building out its capability.
UBS has summed up the investor briefing as a showcase of product and distribution in order to leverage a shift in the industry towards income streams. The obstacle to all of this is the subdued fourth quarter annuity sales and book growth. Hence, the balance is seen teetering between longer-term drivers, which are attractive, and short-term issues. UBS believes the current valuation discount to other Australian financials places too much emphasis on the short term and this should unwind as the platform initiatives ramp up over FY16.
The presentation revealed what is being done to drive the assets in the current low rate environment. There was more disclosure on the property weighting. Direct lending has grown to $2.2bn from $1.2bn over 12 months an now comprises 25% of total fixed income. This trend is worth monitoring, UBS maintains, and could become a concern if it expands further.
JP Morgan observes the company has redoubled its efforts around margins and there could be some modest boost to annuity sales as a result. The ultimate uptake depends on customers willing to take lifetime annuities. Margins have increased as a result of pricing and the heightened exposure to property. The company has indicated it does not intend to increase exposure to growth assets so no further benefits are expected in this area.
Challenger dealt with one concern of Credit Suisse but added another. The company has lowered its FY15 annuity book guidance to 9.0% from 11-13% and prioritised its core long-term products, which the broker considers a sensible reallocation of capital to higher return business. The broker draws some comfort in the company’s ability to sustainably achieve an asset yield above listed corporate bonds. The concern that comes to the fore is the delay in in book growth assumptions, which leads to a reduction in FY17 earnings estimates. Still the stock offers an attractive investment and the broker remains content to retain an Outperform rating.
Deutsche Bank is more comfortable downside risk is limited and has upgraded to Hold from Sell. The broker estimates annuity rate cuts along with higher long-term bond yields have lifted retail annuity margins for new business by 60 basis points since January and the pre-tax returns are lifted to 20.9% from 17.0%, back to over the company’s 18.0% target. Low interest rate may present growth challenges but the new initiatives will underpin sales in FY16 and there is also potential for regulatory reform to be favourable.
The company appears capable of delivering both growth and maintaining margins, in Macquarie’s opinion. A government response to the Financial Services Inquiry and retirement income review, as well a budgetary pressure, should support removal of the structural impediments to retirement income product development. In this sense, Challenger is ideally placed in Macquarie’s view, as regulatory change will support its products. The company’s key platform partners are VicSuper and Colonial First State. in addition, Challenger has a Heads of Agreement with Link/AAS to provide annuities to its members. Challenger expects the arrangement to be operational by the second half of FY16.
Challenger has five Buy ratings and three Hold on FNArena’s database. The consensus target is $7.47, suggesting 11.1% upside to the last share price. Targets range from $6.70 (Deutsche Bank, Morgan Stanley) to $8.30 (Credit Suisse).