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Why Challenger's a buy despite $800m investment loss

The annuities provider this week announced a $300m capital raise to shore up its balance sheet and shift to lower risk credit assets.

Mentioned: Challenger Ltd (CGF)


The company this week announced a $300 million capital raise, comprising a $270 million institutional placement and $30 million retail share purchase plan.

Morningstar equity analyst Gareth James made a slight reduction to his fair value estimate, to $8 a share from $8.10, because of the dilutive effect of capital raising.

But Challenger (ASX: CGF) remains one of the cheapest financial companies on Morningstar Australia’s coverage list. The company’s shares were trading at $4.76 at Wednesday’s market close, a discount of around 40 per cent to James’ fair value estimate.

The company’s primary business is managing and selling annuities — pension products that combine elements of life insurance and investments to provide income for individuals after they retire from full-time work.

Financials

Source: Morningstar

The institutional portion of the placement announced on Monday, brokered by investment banks Macquarie Capital and Goldman Sachs, was $4.89 a share — 8.1 per cent below Challenger’s last traded price ahead of the raise.

Prem Icon Morningstar Premium subscribers can read our analyst's view of the SPP here

At an investor briefing on Monday, Challenger CEO Richard Howes revealed the group’s investment portfolio suffered a paper loss of around $809 million between January and the end of May.

"Raising additional capital will support our business to remain strongly capitalised so we are well placed to withstand and respond to further market volatility," says Challenger managing director and chief executive officer Richard Howes.

Even before the raising, the company remained well within Australian Prudential Regulation Authority’s capital buffer guidelines. Its common equity tier 1 ratio was 1.01 as at the end of May, comfortably above APRA’s minimum of at least 60 per cent of the prescribed capital amount, which sits at 1.63.

Among Challenger’s investment portfolio of stocks, property and infrastructure assets, fixed income comprises around 76 per cent of the total mix.

“And 85 per cent of fixed income comprises investment-grade bonds,” James says.

“Close to 60 per cent of these investment-grade bonds are either liquid, prime or high-grade fixed income securities.”

Challenger intends to further increase its allocation to investment-grade bonds and reduce its exposure to higher-yielding junk bonds.

“While an elevated investment-grade allocation will weigh on near-term earnings growth, we’d rather management maintain this asset quality rather than adding risk to the portfolio to boost returns,” James says.

This prudent capital management partly explains why Challenger ranks among the 13 companies in Morningstar Australia’s research stable that hold an Exemplary stewardship rating, and just one of two financial companies.

Exemplary stewards are focused on creating long-term shareholder value even if it comes at the expense of short-term results, according to Morningstar analysis.



© 2023 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This report has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or New Zealand wholesale clients of Morningstar Research Ltd, subsidiaries of Morningstar, Inc. Any general advice has been provided without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782.

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