Challenger well placed to profit from Australia's retirees
Good results and demographics have put Challenger in a strong position to take advantage of Australia's fast-growing post-retirement sector.
Mentioned: Challenger Ltd (CGF)
Despite some short-term concerns, structural tailwinds have put Challenger in a strong position to take advantage of Australia's fast-growing post-retirement sector, says Morningstar equity analyst Chanaka Gunasekera.
In his latest note on Challenger Ltd (ASX: CGF), Gunasekera says the investment management business remains undervalued, and its fair value estimate intact at $12.60 per share. CGF closed at $11.19 yesterday – an 11 per cent discount to FVE.
Several factors including continuing recognition of the importance of an allocation to annuities in retirement, the transition of Australia's baby boomers into the pension phase, and the government’s proposed new comprehensive income product for retirement, or CIPR, legislation, are long-term tailwinds for Challenger.
This, alongside the firm's dominant market position as an annuity provider and a new series of deals, supports strong earnings growth over the long-term.
"Challenger's new announcement to further expand its distributional reach by making its products available on speciality platform provider, or SPP, Netwealth, along with the previous announcement that its products will be available on Hub24, means its products will soon be available on two of the fastest-growing SPP providers," Gunasekera says.
"This is important because it makes it easier for financial advisers to put their clients into the company’s annuity products and should allow it to continue generating strong annuity sales in Australia."
In fiscal 2018, Gunasekera estimates that Challenger took a little over 70 per cent share of the transfer of funds from the accumulation phase of superannuation to the pension phase that went into pooled annuity products.
The firm reported strong first half fiscal 2019 annuity sales and lower maturities in the Australian market. Gunasekera says sales in the Australian market were enough to compensate for lower sales in Australian-dollar-denominated annuities in Japan, as well as lower institutional sales, and lower inflows than expected in Challenger’s funds management business.
However, analysts harbour some short-term concerns that may weigh on investor sentiment – in particular, a potential fall in Australian property prices.
"Challenger's primary exposure to property includes equity interests in commercial property and to residential-mortgage-backed securities in its fixed income portfolio," he says.
"It's already in the process of reducing its equity interest in property and increasing its allocation to higher-grade fixed-income assets."
Currency movement a risk
Other concerns surround higher interest rates in the US relative to Australia, which Gunasekera says may lead to higher yields on US dollar annuities relative to Australian dollar annuities, thus reducing its sales into Japan, and the potential for a delay in the CIPR legislation.
At round table discussion last month hosted by Schroders, consensus in the room was that the industry was under significant time pressure to implement the Budget 2018 requirements including the banning of exist fees, and that constructing a new and complex retirement income product was unlikely to be accomplished before the 2020 deadline. Those in the room also debated how Labor would view the framework if they were to take power at the next election.
Royal Commission brings uncertainty
On the potential impact of the Banking Royal Commission, Gunasekera remains divided, observing positives and negatives. On one hand, he says that while the firm hasn't been directly impacted by the fallout, sales may be indirectly affected if part of the aftermath is that fewer people seek out financial advisors - given that Australia’s financial advisors are the major distributional channel for selling its annuities.
"However, the first-quarter 2019 results do not suggest this is occurring," he says.
On the other, he says Challenger could gain from the aftermath of the Royal Commission if CIPRs will continue the trend of larger allocations to pooled annuity products in retirement income portfolios and spur more competition in the Australian annuity market.
"The natural competitors to Challenger in this market are organisations that already have an established life business in Australia and are already regulated by the Australian Prudential Regulation Authority," Gunasekera says.
"However, several of these natural competitors have been directly caught up in the Royal Commission and will likely be preoccupied with responding to regulator concerns following the Commission."
Additionally, considerable disruption in Australia’s life industry may work in Challenger’s favour, with several organisations selling their life businesses, which Gunasekera says may reduce the ability of these life businesses to more aggressively compete in Australia’s annuity market.
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Emma Rapaport is a reporter with Morningstar Australia, based in Sydney.
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