Treasure Chest: Challenger

This story features CHALLENGER LIMITED. For more info SHARE ANALYSIS: CGF

The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

FNArena’s Treasure Chest reports on money making ideas from stockbrokers and other experts.

By Mark Woodruff

Whose Idea Is It?

UBS

The subject:

Multi-faceted financial services provider Challenger ((CGF)).

With capital changes pending from the Australian Prudential Regulation Authority, UBS analysis indicates potentially substantial capital relief on annuity products for Challenger, underpinning meaningful upside to the company’s EPS, DPS, and return on equity.

More info:

APRA plans to release a public consultation paper in the June 2025 quarter, indicating it would lower life insurer capital requirements for annuity products by revising its illiquidity premium framework.

UBS notes annuities remain among the most capital-intensive products in Australian financial services, and regulatory capital has historically been a key constraint on Challenger.

The analysts estimate a positive change could initially free up $400-600m in Common Equity Tier 1 (CET1) capital for the company and reduce the capital intensity of fixed income investments by over -20%.

Although a gradual shift in the fixed income mix for Challenger from the current level of around 75% may compress Life spread margins and earnings, cumulative CET1 releases could exceed $1bn.

If these releases are deployed into share buybacks (potentially between $0.5bn-$1.4bn), the analysis suggests a potential lift in EPS by between 8-12%, DPS by 10-30%, and a boost for ROE to between 13-14% from 11.6%, assuming other factors remain unchanged.

Challenger provides a range of financial products aimed at older investors including lifetime annuities, term annuities, fixed term direct, income for aged care, managed investments, and other products across an extensive range of investment services and products.

The company reports across two businesses: Life, a retirement income business selling term and lifetime annuity products to retail and institutional clients; and Funds Management.

Challenger is the dominant provider of annuities in the Australian market.

It should be noted smaller competitor Generation Development ((GDG) may equally be a beneficiary from APRA’s potential change to capital requirements.

Moelis recently suggested this company’s recent partnership with BlackRock could result in a material step-change towards accelerating its growth in annuities funds under management.

Challenger’s growth appears to be well supported as Australia’s Super system enters the retirement phase from an accumulation focus, suggests UBS, supporting a mix shift towards longer-duration longevity risk products.

UBS’s pre-APRA update comes with a firm Buy rating for Challenger, while the broker’s target price has jumped to $9.15 from $7.70.

In mid-April, management at Challenger provided a third quarter update showing total Life sales of $1.4bn, supported by longer-tenor annuity sales.

Retail lifetime annuity sales rose by 22% to $246m, while fixed-term annuity sales jumped by 15% to $505m.

Management suggested longer duration sales would improve book quality and returns, after revealing overall annuity sales rose by 20% to $1bn with strong growth in long duration retail lifetime (up 22%) and a 33% lift in Japanese annuities via the longstanding partnership with MS Primary.

Despite another quarter remaining in FY25, the contribution from the company’s Japanese-market distributors proved greater than the minimum required under their contracts, Ord Minnett noted.

Citi highlighted these Japan and lifetime sales were at record highs as a portion of total sales.

At the time, Managing Director and Chief Executive Officer, Nick Hamilton, noted “Challenger is strongly supportive of the government and regulatory focus to deliver a retirement system for the millions of Australians approaching and in retirement.

“We look forward to APRA’s forthcoming changes to insurance capital standards, which will support significant growth in the lifetime income market and step change balance sheet resilience.”

Resilience is a term not misplaced to describe the company’s March quarter result.

Management tightened the FY25 profit guidance range to between $450-465m from $440-480m, a move analysts largely interpreted as a sign of increased confidence in the FY25 outlook.

A slight increase in the company’s Prescribed Capital Amount (PCA) multiple highlighted the company’s capital resilience, according to Citi, amid a period of widening spreads.

Using that word again, Citi noted Challenger’s resilience to market volatility at the time, suggesting this was a little greater than the market previously perceived.

Macquarie highlighted Retail annuity sales rose 2% year-on-year, while Institutional annuity sales increased by 200%.

Challenger continues to benefit from strong structural growth tailwinds, noted Morgans, underscored by its new partnership with NGS Super.

From 2026, Challenger’s longevity solution will be integrated into NGS’s broader Retirement Income Strategy, offering members guaranteed, regular income for life.

Challenger’s Index Plus sales declined in the first half, and net flows were negative, though Bell Potter noted a key win for a $500m mandate across three- and five-year contracts.

Post UBS’s update, the average target of seven daily monitored brokers in the FNArena database has risen to $7.64 from $7.42. A strong share price performance on the day sees the gap with FNArena’s consensus target narrowing to circa 2% only.

Ofsetting the above is that Morgan Stanley is the only one out of seven daily monitored brokers not rating Challenger shares a Buy (Equal-weight merely translates as Neutral/Hold).

Outside of daily coverage, Goldman Sachs rates the stock a Buy with a $7.40 target and Jarden (Overweight) sits one notch below Buy in its ratings system with a $7.50 target.

Judging from UBS’s research update today, it seems plausible those target prices might be cum upgrade once APRA announces less stringent requirements and brokers update their models.

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