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.
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.
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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.