Company Reports

Challenger’s annuity sales amount to roughly 80% of yearly annuity sales in Australia, while its products are represented on platforms used by the majority of Australia’s financial advisors.

No-moat Challenger delivered a solid fiscal 2024 result, with underlying NPAT rising by 14% from the prior year to around AUD 417 million, broadly in line with expectations. Underlying pretax profits of AUD 608 million slightly exceeded our forecasts, though this was offset by higher taxes. A positive surprise was stronger group profitability—driven by higher net yields from product sales and lower operating expenses. The firm’s guided profit growth of around 10% for fiscal 2025 (assuming the midpoint of the range) aligns with our forecasts and supports our expectations for ongoing earnings growth. We slightly increase our fair value estimate to AUD 7.50 per share from AUD 7.40, reflecting improved long-term maintainable cash flow projections that now assume higher business profitability.

Average earnings for the seven asset managers under our coverage—Challenger, GQG, Insignia, Magellan, Perpetual, Pinnacle, and Platinum—will likely improve over the near term to fiscal 2025, but moderate thereafter. This is partly due to our expectations for continuing net outflows, on average. While potentially lower rates in fiscal 2025 could lead to a cyclical flow uplift, any benefits may be short-lived, as asset class rebalancing activity subsides. Given the cohort’s largely average peer-relative returns, we expect their FUM share losses to exchange-traded funds and industry funds to persist. Competitive pressures are also likely to weigh on fees and earnings.

No-moat Challenger is on track to deliver maintained margin and earnings expansion. We note several ongoing positive trends: Robust growth in lifetime annuity sales, rising proportion of longer-dated annuity sales and new business tenor, and further reductions in product maturity rates. The benefits of this mix shift toward longer-dated products are evident. Guidance for fiscal 2024’s pretax profit increased toward the top end of its guided range—previously "top half"—despite a 10% decline in overall annuity sales in the year to March 2024, relative to the previous corresponding period. This points to revenue from the current asset book being considerably more margin-accretive than in prior years.

Challenger’s annuity sales amount to roughly 80% of yearly annuity sales in Australia, while its products are represented on platforms used by the majority of Australia’s financial advisors.

This note replaces the original version that accompanied our report "Industry Pulse - Australian Asset Managers: 2024 Q1," published March 14, 2024. We were recently made aware of inaccuracies in the net flow data for certain unlisted managers in that original report. As for our investment conclusions, we stand by our key assessments: the fair value estimates, moat, uncertainty, capital allocation, and star ratings for our Asset Manager coverage.

We recently published our inaugural Industry Pulse: Australian Asset Managers 2024 Q1. It has come to our attention that some the detailed industry data we presented may not be accurate, namely around asset manager inflows and outflows. As far as our investment conclusions are concerned, we stand by our key assessments, namely the fair value estimates and moat, uncertainty, capital allocation, and star ratings for our asset manager coverage. Key data for the companies we cover is captured separately and directly from the relevant companies, and we have no reason to believe it is incorrect. However, while we investigate to confirm the accuracy and presentation of the detailed underlying data, we have retracted the report from our products. We will seek to reissue a corrected report, along with an explanatory accompanying note, as soon as practical.

Share prices of ASX-listed asset managers fell for most of 2023 but broadly rebounded late in the year in anticipation of lower interest rates. Stabilizing interest rates generally enhances investor risk appetite, thus boosting fund flows, asset prices, and earnings for asset managers. Globally, net annual fund flows into open-ended, money market, and exchange-traded funds turned positive in March 2023 after close to six months of net outflows. This reflects a stabilizing US federal-funds rate and an increased likelihood of rate cuts in 2024. In Australia, the prospect of cuts in the Reserve Bank of Australia’s cash rate in the near term is likely positive for flows into Australian-domiciled funds—consisting of ETFs, industry funds, and active managers.

Challenger’s annuity sales amount to roughly 80% of yearly annuity sales in Australia, while its products are represented on platforms used by the majority of Australia’s financial advisors.

We marginally lift our fair value estimate for no-moat Challenger to AUD 7.40 per share from AUD 7.30 following the first-half fiscal 2024 results. An 8% intraday rerating in shares follows 16% growth in normalized pretax profits against the previous corresponding period and more upbeat guidance for fiscal 2024. Shares are now close to fair value.

Our conviction in the thesis for listed wealth managers, asset managers, and their related service providers has strengthened after gathering insights from the recent 2023 Super & Wealth Summit, hosted by the Australian Financial Review. These firms are influenced by similar business drivers and industry trends. Most derive their revenue from funds under management and/or administration, or FUMA, which are driven by asset price movements and new fund flows from clients, and management fees or commissions on these FUMA.

Challenger’s annuity sales amount to roughly 80% of yearly annuity sales in Australia, while its products are represented on platforms used by more than 70% of Australia’s financial advisors.

We maintain our fair value estimate for no-moat Challenger at AUD 7.30 per share, with shares mildly undervalued at current prices. The firm is effectively executing its strategy to grow higher-margin product sales in the early months of fiscal 2024. We anticipate earnings margins will continue expanding over fiscal 2024-2028—driven by a favorable shift in product mix and higher yields on investment assets, which should support further rerating of its shares. Continued expansion of institutional partnerships, such as its collaboration with Aware Super; and broader distribution efforts, including selling its products via platform operators like Netwealth, should help Challenger capture its fair share of the growth in the burgeoning annuities market.

Challenger’s annuity sales amount to roughly 90% of yearly annuity sales in Australia, while its products are represented on platforms used by more than 70% of Australia’s financial advisors.

Challenger’s annuity sales amount to roughly 90% of yearly annuity sales in Australia, while its products are represented on platforms used by more than 70% of Australia’s financial advisors.

We trim our fair value estimate on no-moat Challenger to AUD 8.80 per share (from AUD 9.30 previously) after reviewing the annuity provider’s near-term outlook, given significant market volatility resulting from the coronavirus pandemic. Global equity markets have fallen sharply since the start of 2020, with the S&P 500 and S&P/ASX 200 indexes down by about 17% and 25%, respectively. To cushion the ensuing negative economic impacts, the Reserve Bank of Australia has cut the official cash rate to 0.50%, and the U.S. Federal Reserve followed suit by slashing the federal-funds rate by 1% to a range of 0%-0.25%. The widespread investor risk-aversion impacts Challenger’s capital position, as its capital requirements depend on the riskiness of its investment portfolio. Meanwhile, its funds management business also stands to suffer from market volatility attributed to the pandemic. No surprises as Challenger recently lowered its normalised profit before tax, or PBT, guidance to around AUD 500-550 million (from the top end of range previously).

A strong first-half fiscal 2020 result shows the resilience of no-moat Challenger’s business in difficult Australian operating conditions. Our fair value estimate increases to AUD 9.30 per share from AUD 8.20 due to stronger reinsurance than expected of Japanese annuities as well as stronger sales to superannuation and institutional clients seeking guaranteed returns in a low interest rate environment. We also expect better domestic Australian annuity sales and weaker decline in margins. The key takeaways from the half-year results are stronger-than-expected Japanese annuity and institutional guaranteed return product sales which offset weak Australian domestic annuity sales. But management indicate Australian annuity sales improved during the half, with lifetime annuity sales growing 22% faster in the second quarter. The other positive surprise is a softer than expected margin decline despite the higher mix to lower margin Japanese and institutional annuities. In addition, Challenger materially grew its U.K. wholesale pension portfolio, which we expect to add a new income stream from fiscal 2021 and help support margins.

We have transferred analyst coverage of Challenger. We reaffirm our current forecasts, DCF-based fair value estimate of AUD 8.50 per share, and no-moat and high uncertainty ratings. The stock is currently trading at a 9% premium to our current fair value. While we remain optimistic on retail annuity sales growth, we are perhaps slightly more cautious than the market on long-term margins. We forecast a five-year CAGR in EPS of 7% to fiscal 2021.

Challenger Limited's fiscal 2016 profit increased 8% to AUD 362 million, just below our AUD 368 million forecast. With strong annuity sales growth and margins held flat, Challenger is beginning to reap the rewards of its investments to capitalize on a growing retiree market. It is yet to be hurt by the low interest rate environment--demand for annuities continues to rise and to date the firm has been able to pass on lower returns on its investments by lowering returns on the annuities it sells.

Challenger continues to tick along nicely, with total life sales of AUD 864 million in third-quarter fiscal 2016, taking sales for the first nine months of fiscal 2016 to AUD 2.9 billion. While down 1.7% on the prior corresponding period, there was a meaningful pickup in other life sales in the third quarter (mainly reinvestment of maturities), and annuity sales were up 29% on third quarter 2015 to AUD 575 million. Total annuity sales for the first nine months of fiscal 2016 were AUD 2.2 billion, up 9.7% on the prior corresponding period. We make no changes to our sales assumptions. With Challenger's marketing campaigns, increased distribution capability, and new products continuing to attract inflows, we expect a strong fourth quarter. Challenger attributed strong sales growth to recent launches of Challenger annuities on Colonial and VicSuper platforms. The benefits evidenced by 51% of Colonial platform sales coming from advisers who hadn't written a Challenger annuity for three years or more.