Challenger Ltd (ASX: CGF) shares could be a mixed bag today when markets open following the release of its 2019 half-year report. Nonetheless, Challenger shares are still a sell in my book.
Challenger is Australia’s largest provider of ‘annuities’, which are financial products typically sold to retirees who seek reliable income. Challenger was established in the mid-1980’s and listed on the ASX in 1987. In 2018, Challenger managed more than $90 billion between its investment portfolio, which is the sum of the money invested by retirees who buy annuities, and its fund management business.
Challenger Half Year Report
Here are the key numbers from Challenger’s report:
- Total assets under management at $78 billion, up 2%
- $6 million profit, down 97%
- Challenger’s version of profit was down 4% to $200 million (analyst forecasts: $206 million)
- An interim dividend of 17.5 cents per share, flat year over year
- Australian annuity sales up 4%
One of the key differences between Challenger’s version of profit and a commonly accepted definition of profit is Challenger adjusts for significant items and the difference between its investment return forecasts and the actual returns. Basically, when they get it wrong or something unexpected happens the two results might dislocate.
For an explanation of why its statutory profit fell, Challenger attributed the decline to lower returns from its Life (annuities) business and lower fees for performance from its funds management business.
“Our results for the first half have clearly been impacted by the difficult operating environment we’re experiencing, with increased market volatility, industry disruption and political uncertainty playing out across the sector,” Challenger CEO Richard Howes said.
I think Howes is referring to ‘volatility’ that we experienced in December 2018. Click here to learn the difference between crashes and volatility.
“While some of these factors are beyond our control, the fundamentals underpinning our business remain supportive,” Howes added. “Challenger is well placed to manage through the cycle and capture the opportunities for growth we see ahead.”
Outlook Down
According to Challenger, for its full 2019 financial year management expects to report a “normalised” version of profit (before tax) which is between $545 million and $565 million. Last year, Challenger made $547 million.
“This reflects a number of factors including lower than expected 1H19 earnings and flow on effects in 2H19, and impact from a reduction in capital intensity across Life’s investment portfolio,” the company’s update read.
As noted recently, Challenger is not expected to achieve its 18% normalised return on equity target (before tax) in 2019.
It’s… It’s… A Dividend!
According to Bloomberg, analysts were expecting Challenger to pay a dividend of 18 cents per share, slightly more than was declared.
Challenger says it will target a dividend payout ratio of 45% to 50% of normalised net profit (after tax). In my opinion, that could be a signal that dividends may fall in the future. I could be wrong — I’ve been wrong at least once before (wink, wink) — but if Challenger’s profits fall then the dividends will follow suit.
My Take
In my opinion, Challenger’s report was decent, probably better than I expected. But like almost all analysts I have close to zero forecasting ability when it comes to Challenger. I outlined why in the article, “1 Obvious Reason I won’t Buy Challenger Shares“.
While the payment of the same dividend and “supportive” commentary from management were encouraging, I believe Challenger’s business will face more volatility as interest rates rise and valuations — across equity, property and debt markets — become more vulnerable.
What Now?
I don’t own Challenger shares. Why?
I’m not buying into the sustainability of its ‘guaranteed’ retirement income business or the superannuation thematic.
The way I see Challenger’s annuities business is like a defined benefit super fund. There’s a reason defined benefit funds are going the way of the dodo.
Ultimately, I’m not predicting the end of Challenger as we know it. Far from it. What I am saying is I can’t get comfortable enough to buy shares in the company. Put simply, there are so many moving parts and too many assumptions. I don’t understand how any mum and dad investor will have the stomach to hold the shares through a proper market downturn.
Know What You Own
One of the most important pieces of investing advice I received was ‘know what you own and why you own it.’ To do that, we need to do more than throw up another person’s opinion like, “annuities are important because retirees and super and stuff like that”.
Challenger could well be a great play on these thematics. But every investor, from those who buy into cash ETFs to punters in speccy biotechs, should understand the risks of their investments. In markets, there are risks no-one can identify (not even Challenger’s actuaries), but there are risks that you can identify (“known risks”). If you cannot understand and get comfortable with the known risks, don’t invest or buy shares in the company.
There are over 2,000 companies right here on the ASX and thousands of ETFs throughout the world. Be choosey.
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