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Retirement income business Challenger down but not out

Emma Rapaport  |  19 Jun 2019Text size  Decrease  Increase  |  
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Australia’s ageing population will allow annuity provider Challenger (ASX: CGF) to ride out a shorter-term profit hit, even as it suffers fall-out from the banking royal commission and declining interest rates, says Morningstar.

Challenger’s fair value estimate has been cut to $8.20 a share, from $9.25, in response to management’s lower profit guidance issued at an investor day late last week.

The weaker outlook was attributed to a reduced growth forecast for Challenger’s equity portfolio from fiscal 2020, and disruptions in its key financial adviser distribution network.

Following the shareholder announcement last Thursday 13 June, share prices tumbled 9 per cent to $6.95.

However, Morningstar equity analyst Chanaka Gunasekera says Challenger’s “long-term tailwinds” are intact, and that the firm will likely benefit from Australia’s demographic shift.

“Challenger is well positioned to take advantage of the long-term structural tailwinds of an ageing demographic and roughly $67 billion being transferred each year to the pension phase from the allocation phase of superannuation in Australia,” he says.

The proportion of Australians aged 65 or older has been steadily increasing over the last century – from one in every seven people in 2011, or 14 per cent, to almost one in six people, or 16 per cent, in 2016 according to the Australian Bureau of Statistics. The ABS expects this trend is to continue.

Gunasekera also believes Challenger’s annuity sales will be further supported by its agreement with Mitsui Sumitomo Primary Life Insurance to sell US-dollar annuities in Japan from 1 July 2019. This will complement its ongoing sale of Australian-dollar annuities.

Gunasekera says management’s long-term confidence is reflected in its overlooking near-term headwinds and maintaining dividends at fiscal 2019 levels during fiscal 2020 – despite lower-than-expected underlying net profit after tax.

At the last close of $6.54, Challenger is trading at a 20 per cent discount to Gunasekera’s fair value estimate.

Lower profit forecast

Challenger’s fiscal 2019 underlying NPAT guidance has been reduces to $398 million, from the previous forecast of $402 million. The damage occurs from fiscal 2020, with underlying NPAT forecast at $369 million, from $402 million previously.

In addition to a lower equity growth assumption and a one-off $15 million investment flagged for fiscal 2020, Gunasekera says earnings are also being hit by Australia’s lower interest rate environment and the outlook for a higher tax rate from next year.

Knocked by the Hayne inquiry

Challenger escaped the hot seat at the Kenneth Hayne-led banking royal commission, but Gunasekera says they haven’t entirely avoided the fallout.

The exodus of financial advisers from major financial services hubs including AMP and the major banks has disrupted Challenger’s key financial adviser distribution channel – and Gunasekera says this will remain a headwind for the next few years.

Sales of Challenger products from major financial services providers were down 25 per cent on the prior corresponding period.

Though equivalent sales from independent financial advisers are up 26 per cent on the prior corresponding period, Gunasekera says this wasn’t enough to offset the losses.

In the meantime, Challenger is working to mitigate this effect by building deeper relationships with independent financial advisers who offer annuities to their clients, as well as strengthening its ties with advice platforms netwealth and HUB24.

is a reporter for Morningstar.com.au

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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