Australia | Jun 14 2018
Challenger is reducing property and increasing fixed income exposure, which will deliver a negative impact on margins and earnings in the near term.
-Near-term cost to earnings but more sustainable future book growth
-Opportunity to increase allocation to higher investment grade assets
-Changes to means testing rules may be less punitive to lifetime annuity sales
By Eva Brocklehurst
Challenger ((CGF)) is reducing property and increasing fixed income exposure as it juggles its portfolio for the future. This provides for a less capital intensive model and greater ability to fund its own growth. A negative impact is envisaged by brokers for margins and earnings in the near term.
Operating from a more sustainable platform should enable Challenger to better capitalise on the growth opportunity from recent regulatory changes, Citi observes, as it becomes less reliant on equity raisings to support future book growth.
This improved ability to fund growth is the main offsetting positive, the broker adds, and also signals the company is confident in future growth, and appears to be the main motivation for the change rather than relative risk premia.
Although, the broker acknowledges, the current differentials in risk premia make it relatively fortuitous to be planning such a change at this time.
UBS agrees that, while there is a near-term cost to earnings, the decision provides for a more sustainable footing for funding annuity book growth in the longer term and this is a sensible trade-off.
Ord Minnett believes tough market conditions, where yields are being compressed, has forced Challenger to provide an offset by showing considerable book growth.
This implies potentially higher funding costs than might otherwise have been the case and, in such an environment, the broker suspects there may be constrained pre-tax profit growth.
Property allocation will be reduced to the mid teens, from 21%, which represents around $700m in asset sales. Challenger believes strong demand from offshore capital is flattening the returns in that asset class.
Once the transition is completed Citi estimates an adverse impact of around -5% to earnings per share from the changed allocation, but in the longer term this is likely to be less.
Citi has previously observed book values are relatively conservative and Challenger should, therefore, be able to achieve a profit on sale from the properties on disposal. Yet, given the disposals are one-off in nature, and there is uncertainty regarding the quantum and timing, no allowances are made in estimates.