Challenger Financial Services: Not as clean as hoped

About the author:

Author name:

By Richard Coles

Job title:

Senior Analyst

Date posted:

17 August 2022, 9:00 AM

Sectors Covered:

Insurance, Diversified Financials

• Challenger Financial Svcs' (ASX:CGF) FY22 normalised NPBT (A$472m, +19% on pcp) was in-line with Bloomberg consensus and company guidance (top end of the A$430m-A$480m target range).
• Overall, this result was a bit weak in our view, with a reasonable current year performance offset by the negatives of a softer FY23 outlook than expected, and a decision to conduct a strategic review of the bank.
• We lower our CGF FY23F/FY24F EPS by 3-5% mainly reflecting higher annuity run-off rates and operating expense growth assumptions per FY23 guidance.
• While this result had some disappointing areas, the mid-point of FY23 guidance does still imply ~7% EPS growth this year and we continue to believe rising interest rates will provide a multi-year tail-wind for CGF. Trading on 14.5x we see reasonable value medium term and we maintain our ADD call.

Event

CGF’s FY22 normalised NPBT (A$472m, +19% on the pcp) was in-line with Bloomberg consensus and company guidance (top end of the A$430m-A$480m target range). The 2H22 dividend of A11.5cps was also in-line with consensus.

CGF’s FY22 reported NPAT (A$254m, -57% on the pcp) was 22% below consensus affected by the impact of unrealized mark-to-market investment losses.

The mid-point of FY23 NPBT guidance (A$485m to A$535m) was 3% below consensus (A$528m). CGF announced it will conduct a strategic review of the small bank it acquired in 2020, while the company and Apollo (NYSE: APO) have signed a binding agreement for their lending JV targeting specialized areas.

Overall, this result was a bit weak in our view, with a reasonable current year performance offset by the negatives of a softer FY23 outlook than expected, and a decision to conduct a strategic review of the bank.

The good

1. The Life COE margin improved in 2H22 on 1H22 (2.63% vs 2.56%) benefitting from higher returns on shareholder funds and an improvement in the product cash margin (+4bps ex the Accurium sale).
2. FY22 CGF total life sales (A$9.7bn) were +40% on the pcp, with 4Q22 growth being +95% on the pcp.
3. CGF’s total life book grew a healthy 6% in 2H22, albeit this was below the strong 1H22 result (8.4%).
4. The FY22 life Business EBIT (A$472m) was +18% on the pcp driven by 14% average AUM growth and a stable COE margin (on a full year basis).
5. The group ROE would have exceeded target excluding the negative bank performance (12.5%).
6. Funds Management EBIT (A$82m) rose 17% on the pcp.
7. The Life PCA capital ratio (1.6x) is at the top of management’s target range (1.3x-1.7x).

The bad

1. The mid-point of FY23 NPBT guidance was 3% below consensus, while the bottom end of guidance implies minimal growth into next year (+3%).
2. The gap between group underlying and reported profit was large (A$472m vs A$254m) due to negative mark-to-market adjustments.
3. CGF expects 5-6% operating expense growth in FY23 due to inflationary pressures.
4. The bank review was unexpected and seemingly highlights a poor investment overall (FY23F EBIT = - A$10m); 5) The forecast FY23 annuity run-off rate (34%) is well up on FY22 (28%) due to higher 1 year institutional sales in FY22.
5. FY22 FM FUM (A$94bn) was down 14% on 1H22 (A$109bn) due to an asset sale, institutional outflows (-A$6bn) and market movements.
6. Japanese annuity sales (A$617m) were -22% on the pcp.

Changes to forecasts

We lower our CGF FY23F/FY24F EPS by 3-5% mainly reflecting higher annuity run-off rates and operating expense growth assumptions per FY23 guidance.

Our price target is set at (login to view).

Investment view

While this result had some disappointing areas, the mid-point of FY23 guidance does still imply ~7% EPS growth this year and we continue to believe rising interest rates will provide a multi-year tail-wind for CGF.

Trading on 14.5x, we see reasonable value medium term and maintain our ADD call.

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