Challenger Challenged By Market Volatility

By Glenn Dyer | More Articles by Glenn Dyer

Well, that was an unexpected shock for Challenger Ltd, the annuities and fund management group whose shares were well and truly punished yesterday after it revealed that first-half earnings had been almost wiped out by the volatile stock markets in November and December.

Challenger shares fell more than 15% after it told the market in an update that it now expects to report normalised net profit after tax of just $6 million and not the $200 million plus forecast at the annual meeting last October.

The company thought tried to spin the result saying its “normalised” profit was more than $200 million.

Investors didn’t fall for that line and marked the shares down. They ended down more than 17% at $7.65.

Challenger said that a negative “investment experience” of $194 million over the half-year included $153 million related to the investment assets of its life business as lower equity markets and wider fixed income credit spreads bit into the result.

Earnings were hit by the higher market volatility, with funds under management performance fees of $2 million, down $4 million from the comparable period a year ago.

Statutory net profit for the half year is expected at $6 million, the company said.

But Challenger attempted to spin this rotten result by emphasising what it called “normalised” pre and post tax profit figures.

For example it said “normalised” profit before tax would be around $270 million and a “normalised” net profit after tax of $200 million for the December half year when the audited accounts are released next month.

Normalised profit for the December 2017 half year was $207.9 million

The firm cut its fiscal year guidance to a range of $545 million to $565 million.

The company claims this ‘normalised figure’ is more accurate for Challenger’s type of business.

“The normalised profit figures are non-statutory amounts and in Challenger’s view better reflect the underlying operating performance of the business. The normalised profit figures exclude investment experience and significant items. Investment experience includes both assets and policy liability experience and net new business strain. Asset and liability experience is calculated as the difference between actual investment gains/losses (both realised and unrealised) and normalised capital growth in relation to assets, plus any economic and actuarial assumption changes in relation to policy liabilities for the period.

“New business strain results from using the risk-free rate plus an illiquidity premium to value term and lifetime annuities. New business strain is a non-cash item and subsequently reverses over the future period of the contract. The normalised profit also excludes any significant items which represent non-recurring income and expense items for the period.

“The normalised profit framework and reconciliation to statutory profit have been discussed in Section 8 of the Operating and Financial Review in the 2018 Annual Report. The normalised profit is not audited,” the company explained in a footnote in yesterday’s statement

But it is not a standard way to report profit and the statutory result reveals the impact of those stock market fluctuations, especially in December, on its finances.

It is quite possible that the recovery on markets since the start of the year and less volatile trading conditions will see that “negative investment experience’ reversed or mitigated to a degree in the current half year period.

But it is a bit rough for a company to claim that adverse market moves should not be taken into account by investors when they made such a mess of the statutory result in the December half. On that basis, Challenger should also exclude the impact of any improvement in the six months to June 30.

Challenger Chief Executive Officer Richard Howes said that while conditions are challenging he remains very positive about the future.

“Challenger has a strong track record of success through the cycle, which gives me confidence in our performance over the longer term. We continue to be well placed to take advantage of growth in the retirement income market,” Mr. Howes said in yesterday’s statement.

Glenn Dyer

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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