Focus On Longer-Duration Annuities And Technology Will Improve Future Efficiency

Key Takeaways

• Strategic sales shift to longer-duration annuities boosts book quality, earnings, and ROE, with a focus on lifetime and Japanese annuities.
  
• Investments in technology and partnerships enhance operational efficiency, scalability, and margins, supporting future revenue and dividend growth.
  
• Interest rate sensitivity, accounting volatility, tight credit spreads, and execution risks may impact Challenger's revenue, profit stability, investment yields, and operational efficiency.

Catalysts

A publicly owned investment manager.

• Challenger has been strategically remixing its sales towards longer-duration annuity liabilities, particularly lifetime and Japanese annuities, which has improved the quality of their book. This reduces maturity rates and supports higher book growth, positively impacting earnings and ROE.
  
• The company is heavily investing in upgrading its customer technology platforms, which is expected to remove sales frictions, enhance user experience, and drive future growth and operational efficiencies, potentially boosting revenue and margins.
  
• Challenger's partnership with State Street to overhaul its investment administration capability offers scalability benefits and technology enhancements, which could lead to reduced costs and improved margins over time.
  
• Expanding its asset origination capabilities, particularly in private credit through Challenger Investment Management and whole loan origination, has been identified as a key growth area to drive yields and support investment returns, thus positively affecting earnings.
  
• The company's strong capital position with excess regulatory capital provides resilience to market volatility and supports investments for future growth, ultimately maintaining a strong ROE and enhancing shareholder value through improved earnings and dividend growth.

Challenger Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Challenger's revenue will decrease by 32.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 4.1% today to 46.8% in 3 years time.
• Analysts expect earnings to reach A$517.3 million (and earnings per share of A$0.69) by about February 2028, up from A$147.2 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as A$430.5 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.1x on those 2028 earnings, down from 26.0x today. This future PE is lower than the current PE for the AU Diversified Financial industry at 16.9x.
• Analysts expect the number of shares outstanding to grow by 0.76% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.9%, as per the Simply Wall St company report.

Challenger Future Earnings Per Share Growth

Risks

• Potential sensitivity to interest rate changes, especially concerning the yield curve affecting term sales, could impact the revenue and earnings growth by influencing sales of term annuities.
  
• The difference between statutory and normalized profits due to non-cash accounting adjustments and property revaluations suggests volatility in reported profits, potentially affecting investor confidence in earnings stability.
  
• Tight credit spreads and the reliance on alternatives like absolute return funds come with risk, as lower-than-expected returns from these investments could impact investment yields and overall margins.
  
• Large and abrupt market or currency movements, particularly regarding adjustments in the property portfolio or Life risk business, may lead to significant valuation mismatches, impacting net profit and balance sheet strength.
  
• Execution risks associated with technology platform upgrades and dependency on the seamless transition to new systems with partners like State Street could affect operational efficiency and cost management, potentially influencing net margins.

Valuation

• The analysts have a consensus price target of A$7.07 for Challenger based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$7.8, and the most bearish reporting a price target of just A$5.95.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be A$1.1 billion, earnings will come to A$517.3 million, and it would be trading on a PE ratio of 13.1x, assuming you use a discount rate of 10.9%.
  
• Given the current share price of A$5.56, the analyst price target of A$7.07 is 21.4% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.