Challenger (ASX:CGF): Apollo’s sell out was their loss but other investors’ gain!

When we last wrote about Challenger (ASX:CGF), in September 2024, investors were panicking because Apollo (a global fund manager that had a fair stake in the company) sold $460m worth of shares, taking its stake from over 20% to under 10%.

The concern was not just over the lack of confidence it showed as an investor, but also as a partner – Apollo provided certain products Challenger distributed and we believe investors thought this relationship was under threat. The irony is that Apollo did end up selling more of its shares (at least enough to take it below 5% and perhaps all of its stake) and it lost its board representation, but is still a distributor of Challenger products. Some of those shares were reportedly purchased by TAL Dai-ichi Life which also acquired Challenger shares from a fellow Japanese life insurance distributor MS&AD.

But Challenger has had positive momentum in the last 12 months that has proved doubters wrong.

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Challenger (ASX:CGF): A fundie for retirees

Challenger’s specialty is lifetime annuities, providing retirees with guaranteed regular income payable for life – from lump sums given up front. These are the perfect solution because they accelerate with inflation, along with beneficiary needs. They also don’t crash when the stock or bond markets do. 3-year fixed annuities are priced attractively and tend to outperform conventional Term Deposits. It is mostly focused on Australia, but since 2016 has serviced Japan’s retirement market too.

Challenger also provides allocated pension and superannuation products. This is a terrific space to be in, not just because the Baby Boomers are retiring but because they will live longer than previous generations, and also because they have among the highest life expectancies globally. Oh, and did we mention Australia’s superannuation system? This ensures there is some money to splash around in retirement, although the challenges is managing it. And Australia’s superannuation assets are expected to nearly triple to over US$9tn by 2042.

Challenger is recording good results

In FY24, Challenger made a $608m profit before tax and a $130m profit after tax (up 17% and down 24% respectively compared to restated FY23 results, although the company’s EPS was up 14%). It closed the year with $127bn Assets Under Management and a 15.6% Return on Equity.

The company had told investors to expect an FY25 post-tax profit of $440-480m on a normalised basis and a $640-700m profit before tax, assuming a 31.3% tax rate. It set an ROE target of the RBA cash rate plus a margin of 12%, and told investors this would be achieved in FY25.

Challenger delivered the goods with a $456m underlying post-tax profit (up 9%). Its statutory profit was only $192m but up 48% from the year before. Its ROE was 11.8% and its AUM was $123.9bn. Annuity sales totalled $5.2bn ($984m of which came from Japan) and total life sales were $8.6bn.

The long term looks good, but the shorter term is uncertain

As any company does, Challenger has told investors it has a lot to look forward to. It noted 8.9m Australians will be over 60 in the next 20 years – 780 retire every single day. No surprises here but 78% of Australians would be happier with a guaranteed income for life.

Challenger is already a major industry player but is still going for more growth. New partnerships with super funds, wealth platforms, and more institutional clients, plus new product forms (such as income notes), could widen the customer base beyond traditional retirees.

If APRA’s proposed reforms to annuity-product capital requirements go through this could reduce capital costs and volatility for Challenger, potentially boosting its profitability and capacity to expand. For those wondering what we’re talking about, APRA has proposed taking the illiquidity premium needed for longevity products from a one size fits all for all providers to permit insurers to provide a more risk-sensitive premium.

Specifically companies could apply a higher discount rate if they could show strong risk controls, governance and if the standard rate wouldn’t reflect a company’s annuity liabilities and cash flow from backing assets could apply a higher discount rate which would lower the liability valuation and reduce the amount of capital needing to be held against those assets. This could come with the trade off of updated risk-control requirements, but this could be a price Challenger is willing to pay. But we digress.

Challenger is facing some challenges, particularly in its Funds Management division that has seen net outflows recently. Also keep in mind that annuity profitability depends in part on yields/returns on underlying assets; if interest rates or bond yields fall, that could pressure margins.

Also, no matter what Gen Z stereotypes about Boomers may suggest to the contrary, economic stress can be a thing amongst older generations and this may reduce retirees’ capacity or appetite to commit substantial upfront lump sums for annuities.

Although Challenger dominates the annuity space, changes in regulation, competition, or consumer preferences (e.g., toward flexible drawdown rather than fixed income) could pose threats.

Challenger is anticipating more growth in FY26, but modest growth

For FY26, it has given the same ROE target of the RBA cash rate plus 12% after tax. Its EPS guidance is $0.66-0.72 with the midpoint being 4% higher than FY25. This would translate to a profit of $455-495m.

Consensus estimates call for $0.65 EPS on a normalised (i.e. underlying basis) and for $1,018.4m revenue, up from $977.7m the year before. FY27 is expected to be another nuanced year with $1,073.7m revenue and $0.70 EPS projected. Then for FY27, $1,131.1m revenue and $0.74 EPS.

Analysts’ mean target price is $9.47, up 5% from the current price. Its multiples are reasonable with 12.9x P/E and 0.6x PEG. Nonetheless, this has to be compared to the more nuanced growth of the business.

Conclusion

This could be a good stock for investors wanting slow and steady returns, just like that which Challenger claims to offer customers. But investors wanting quick growth would be better off sticking with other sectors.