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One stock with a very bright future

Financial Services | Comments (18)

One stock with a very bright future

Challenger Financial Limited (ASX: CGF) has defined the annuities market in Australia, and appears to be one of the few businesses on the ASX that is exposed to enduring (multi-decade) structural tailwinds. We consider it to be one of the highest quality companies on the ASX. This view is also supported by a recent market survey.

Consider these points in light of Challenger’s business model:

  • At the latest half year result, Challenger’s CEO said; “Retail annuity sales have continued to grow strongly yet we’re only four years into the 20 year retirement phase of Australia’s 4 million plus Baby Boomers. As the wealthiest generation in history, the boomers have a lot to lose, so place a very high value on capital preservation.”
  • Assets in retirement are projected to quadruple in this decade alone. This basically means that as more and more boomers retire, the level of assets which Challenger services is expected to grow by a factor of four.

There is currently $66 billion transitioning out of the wealth accumulation phase and into the decumulation (retirement) phase in Australia every year. If industry forecasts are right, within 10 years this will grow to in excess of $200 billion, a compound annual growth rate (CAGR) of approximately 13 per cent.

How many markets in Australia can you point to that will grow by this magnitude over the coming decade, with very few negative outliers? From our calculations we believe this will be very uncommon.

  • Of the current pool of funds flowing into the retirement phase, just 4 per cent is directed to annuities. If the Australian market follows the trend of more mature decumulation markets overseas, this will likely triple to between 10 and 15 per cent of funds.
  • Regulators and financial planners have more recently demonstrated a willingness to accelerate growth in annuity adoption. One such regulatory tailwind comes from David Murray’s Financial System Inquiry, which points to the Government looking seriously at incentivising retirees to purchase larger and larger amounts of their wealth as long-term income streams.

And so we come to our final point.

In terms of Australia’s largest financial product distribution force, financial planners, a recent survey conducted by Investment Trends clearly shows that annuity recommendations are on the rise:

  • “The number of financial advisers recommending annuities to their clients has increased to 38 per cent in 2014, up from 32 per cent in the previous year.”
  • “In addition to already increasing usage, the intention to use annuities has also increased with 59 per cent of planners intending to recommend annuity products in the coming year, up from 45 per cent saying so in the previous study”.
  • “Among planners who recommended income guaranteed products in the last 12 months the vast majority, 86 per cent, used a Challenger product.”

Challenger has gone through a bumpy six months for reasons that we have previously mentioned here. Business growth is rarely smooth, but for this business, we are willing to back its bright future and structural tailwinds which are likely to deliver a decade of growth that should be smoother than most.

The Montgomery [Private] Fund and The Montgomery Fund is a shareholder of Challenger Financial Limited (CGF).

Russell Muldoon is the Portfolio Manager of The Montgomery [Private] Fund. To invest with Montgomery, find out more.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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18 Comments

  1. Kelvin Ng
    :

    Hi Russell, Andrew and Roger, what do you think of PIMCO’s stated intention to enter the annuities market in Australia?
    Thanks.
    Kelvin

    • Roger Montgomery
      :

      Confirms that there’s plenty of opportunity in the market. Size is important so for a long time, investors should be safer investing with the first, who has become the largest – Challenger.

      • Roger Montgomery
        :

        Just because I am the world’s biggest seller of trucks doesn’t mean I am going to win an F1 race. ‘Big’ always casts a significant shadow that investors jump at. But jumping at shadows (big or small) can be a very expensive and wasteful investment strategy.

  2. Adrian Totols
    :

    Dear Goldilocks,

    The use of annuities in the pension stage is a useful one. Advisers get a commission for the sale of such products. The commission structure is based on the amount invested and the guaranteed income stream. I note such products can be a drain on company profits when the investment streams for the product decline. I note that such investments can be in the American property market. The investments may be in US office space which has had problems since the GFC and is only now showing green shoots. The old issue of the chase for rental yield, abit without fully franked dividends.

    I note that Challanger has had its new product approved for Centrelink purposes, the product placed on advisers lists and allowing inflows to grow.

    An old retiree, using the direct method of share investment in the Australian Share Market, investing in Australian Banks gives a decent yield and capital growth strategy. I note that the banks are fully priced to COB yesterday, a small drop today. May be go away in May ???

    Kind regards,

    Adrian Totolos.
    Business Analyst.

      • Adrian Totols
        :

        Rogé,

        Split Enz says “‘History Never Repeats”. How ever the data tells another story.

        Regards,

        AT.

      • Adrian Totols
        :

        I note Challanger’s Jeremy Cooper [echoing our frequent comments regarding millionaires no longer being rich] said in todays SMH that $1 million dollars in retirement is not enough ( if it invgested in a Challanger Lifetime Annuity) The calc he provides is for a income stream of $1297 per fortnight for a lifetime. This make a ROI on the $1million dollars of just 3.11% pa. I note that this a “lifetime contract to comply with Centrelink rules, and if the life insured dies, the life company take the funds invested. In another word you are betting against the life company to live to for at least 30 years to get the funds invested back from the life company.

        Funds invested in equities (Domestic banks) will all ways outperform this over the 30 year time frame. The search for income stream from yield and imputation credits will provide the income stream for the growing number of retirees of today and tomorrow.

        Kind regards,
        Adrian

  3. John E
    :

    A few points on CGF:
    – Solid Q3 result. Life book growth as expected.
    – Net profit will be patchy over the course of this year as they are now paying tax. But we now get franked dividends. This may be causing the results shown in Skaffold.
    – The debt situation is mostly due to the legacy mortgage book which is in run off. Outstanding debt keep falling as loans are paid down.

  4. Patrick Poke
    :

    I’ve held CGF for about 3 or 4 years now, it’s one of my favourite holdings. The valuation looks a little stretched to me based on current figures, but looking forward it seems very attractive, so I’ll continue to hold. I hope to hold CGF for many years to come. It does seem to be a bit of a ‘one-sided bet’ at the moment, with all the risk being to the upside in my opinion. If the recommendations from the Murray report are taken up, it should provide a huge boost to their business.

  5. Jim Hasn
    :

    Thanks Russell. I am also a CGF fan due to the long term prospects and topped up with the recent price drop. However, a check on Skaffold shows it to be a C5 company with as many green ticks as red crosses. There is no reference to this in your discussion.

    • Roger Montgomery
      :

      Hi Jim,

      You have to satisfy yourself of the risks, which are inherent in every investment. The C rating needs to be assessed with an understanding of the debt structure.

  6. James Price
    :

    Roger/Russell
    Thank you for another enlightening insight. However, I for one would appreciate some clarification.
    You stated: “We consider it (CGF) to be one of the highest quality companies on the ASX.” Yet despite the ‘opportunity’ for growth in the article Skaffold presents a very different picture: C5 quality score (its worse in 10 years); declining ROE forecast; D/E ratio over 200%; declining EPS forecast; and currently selling 30% above its intrinsic value. Hardly the hallmark of the RM teachings.
    Perhaps you might like to enlighten us further on the use of Skaffold as an analytical tool to identify investment ‘gems’ such as CGF!

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