Challenger Financial Services Growth overshadowed by spread impacts CGF has released its 3Q21 performance update. 

Overall, we saw key growth metrics delivered in 3Q21 as robust, with domestic annuity sales (A$1.38bn) up 400% on pcp and life net book growth of 9%. Strong growth metrics, however, were overshadowed by NPBT guidance being lowered to the bottom end of the target range (A$390m – A$440m). 

We downgrade CGF FY21F/FY22F EPS by -3%/-1% on more conservative margin forecasts, offset somewhat by higher sales/book growth expectations. 

Our PT falls to A$6.34. While the current year downgrade was disappointing, we think the 15% fall in CGF’s share price is overdone, particularly noting improved sales and book growth trends in recent quarters. ADD maintained. 

What happened

Challenger Financial Services has released its 3Q21 performance update. Overall total annuity sales (A$2.4bn) rose 155% on pcp and 30% sequentially, and life investment assets grew 6% for the quarter. Funds Management FUM rose 9% over the quarter, with quarterly net inflows of A$7bn in 3Q21. CGF has revised FY21 NPBT guidance to now be at the bottom end of the previous target range (A$390m to A$440m), which management attributed to the sharp decline in credit spreads over the year.

 A good quarter from a growth perspective Overall, we saw key growth metrics delivered in 3Q21 as robust. Indeed the 9% total life net book growth that CGF produced for the quarter is almost double its previous record level (5.2% in 1Q20). Pleasingly, it was a particularly strong quarter for domestic fixed term annuity sales (A$1.38bn), which rose 400% on pcp (A$277m) and 79% sequentially (A$667m).

 Institutional sales of A$847m were also solid, albeit they were down 6% from the record level in 2Q21 (A$903m). Japanese sales (A$79m) were arguably the soft point in the quarterly update, being well down on 1Q21 and 2Q21 levels (A$392m and A$152m). 

However, we note YTD Japanese sales (A$622m) are tracking to exceed the minimum level promised in the MS Primary contract (A$670m pa). Margin squeeze On reduced guidance, management said this was driven by lower margins being offered to newer clients, together with longer sales lead times making it harder to pass through the impacts of declining spreads to customers. 

CGF noted it is responding to the impacts of tighter spreads through its annuity pricing. While we acknowledge corporate bond spreads have broadly halved in the last year, we were surprised at this downgrade, believing the benefits of CGF deploying excess capital into higher returning investments would negate these pressures. 

However, looking into FY22, the benefits of stronger recent growth does offset our more conservative margin forecasts to some degree. Changes to forecasts We downgrade CGF FY21F/FY22F EPS by -3%/-1% on more conservative margin forecasts, offset somewhat by higher sales/book growth expectations. 

Our PT falls to A$6.34. While the current year downgrade was disappointing, we think the 15% fall in CGF’s share price is overdone, particularly noting improved sales and book growth trends in recent quarters. ADD maintained.

Company description Challenger is a financial services firm focusing on retirement products. It operates two core businesses – its Life division and its Funds Management division. 

Challenger Life provides annuities and guaranteed retirement income products that distribute cash flows with protection against market movements, inflation and other risks. Its Fund management unit (predominantly Fidante Partners) comprises a number of boutique investment managers.

Challenger has profit share arrangements in these managers in return for providing admin and distribution services. The division also manages assets with the focus on return for the Life business and other investors.

Changes to forecasts We downgrade CGF FY21F/FY22F EPS by -3%/-1% on more conservative margin forecasts, offset somewhat by higher sales/book growth expectations. Our PT falls to A$6.34. While the current year downgrade was disappointing, we think the 15% fall in CGF’s share price is overdone, particularly noting overall improved sales and book growth trends in recent quarters. ADD maintained.

Downside risks to our Add call are: 1) an inability for CGF to maintain strong sales and net book growth; 2) lower asset yields seeing a significant retraction in CGF’s life COE margin; 3) unforeseen negative regulatory change; and 4) a large rise in defaults affecting CGF’s investment portfolio.