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ASX stock of the day: Challenger (ASX:CGF) shares up 6%

Challenger Ltd (ASX: CGF) shares are surging today, up more than 6%. Here’s what’s going on with this annuities provider today.
The post ASX stock of the day: Challenger (ASX:CGF) shares up 6% appeared first on Motley Fool Australia. –

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The Challenger Ltd (ASX: CGF) share price is on the move today. Challenger shares are up 5.94% at the time of writing to $5.71 a share.

Today’s moves come on top of what has been a great month at the tail end of a wild year for Challenger.

Challenger shares are up 18% over the past month. However, they also remain down more than 30% year to date, and more than 44% off the highs we saw in February. Even worse for shareholders, Challenger’s all-time high of $14.17 that we saw back in December 2017 is a distant memory. The shares are still down 60% from that level on today’s prices.

What does Challenger do?

Challenger is an asset manager at its core. It has four divisions: Challenger Life, CIP Asset Management, Fidante Partners and Accurium.

CIP is an institutional funds management business that works in fixed income, real estate and derivative strategies. According to the company, its Fidante division “invests in and forms long-term alliances with talented professionals to create, grow and support specialist, boutique funds management businesses”. Accurium provides self-managed super funds (SMSFs) with assistance and services for clients in, or transitioning to, retirement phase.

However, it’s the Challenger Life division that is the company’s crown jewel. For one, it contributes the lion’s share of income to Challenger. Net income from the Life division was $639 million in FY2020, out of a total of $797 million for the Challenger Group. That’s just over 80%.

Challenger Life is an annuity provider. An annuity is a secure, guaranteed income that is paid for your lifetime, or for a fixed term. You basically pay a lump sum of cash to Challenger, and in return receive a fixed income stream for the terms agreed upon. Challenger takes this capital, invests it and then keeps any gains above what is required to pay out in annuity payments as profit.

Annuities – a double-edged sword

The appeal of Challenger’s annuities has increased in recent years (sales were up 13% in FY20). However, the same factors at play here are making it harder for Challenger to generate profits. Let me explain.

The appeal of an annuity, as opposed to owning dividend-paying ASX shares, for example, is the certainty. Although an ASX dividend share might offer, say, a trailing 5% dividend yield, there is no guarantee that the company will continue to pay the same yield, year in, year out. That inherent uncertainty does not suit some investors, who might prefer a lower, but safer yield. That’s where companies like Challenger come in.

But it’s not much easier for annuity-style businesses to generate the necessary yield to fund these payments. In the days of yore, investors looking for guaranteed income would turn to cash or fixed-interest investments. but in a world of near-zero interest rates, these kinds of investments don’t have the chops to put real, meaningful returns on the table. As an example, the current running yield for a 10-year Australian government bond is currently just 0.88% per annum.

So whilst Challenger’s annuities are increasing in popularity, the company’s ability to generate returns above the level it costs to provide the annuities is shrinking. 

Why are Challenger shares on the rise today?

Because of the nature of its business model, Challenger is a very cyclical stock. Thus, it tends to outperform the broader share market in good times, and underperform in bad times. That’s because the market knows Challenger has a lot of money invested in assets itself, so a rising market is likely to translate into rising profits for the company, and vice-versa.

But Challenger also released some good news to the markets today as well. In a release this morning, Challenger told investors that S&P Global Ratings has completed their annual ratings review and reaffirmed Challenger’s Life business with an ‘A’ rating, and a ‘stable outlook’. It has also reaffirmed the Challenger Group’s rating at ‘BBB+’, also with a ‘stable outlook’. This has positive ramifications for the interest rates which Challenger can borrow money and issue bonds at.

This positive news is likely to be contributing to the Challenger share price appreciation we are seeing today.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Challenger Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The post ASX stock of the day: Challenger (ASX:CGF) shares up 6% appeared first on Motley Fool Australia.

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