Challenger swings to full-year loss, to keep defensive stance

Challenger will keep a more defensive portfolio after a $750m hit in the COVID market rout dragged it to a full-year loss.

Richard Howes, CEO of Challenger. Britta Campion / The Australian

Challenger shares slumped more than 7 per cent on Tuesday, hitting a three-and-a-half month low, after the annuities provider flagged it would maintain a more prudent approach with its investments in the wake of the $750m hit it took in the COVID-19 market rout.

Handing down its fiscal 2020 result, headlined by a $416m statutory loss for the year, Challenger chief executive Richard Howes said the company’s defensive strategy would help protect against further market volatility as he cautioned on the disconnect between markets, which were looking through the COVID-19 risks, and the overall economic outlook.

“When you look at the scale of the policy response by central banks globally and the scale of the fiscal response globally, it’s easy to understand how asset prices can rally.

“But I think as we look forward, given the nature of that rally and the disconnect between markets and heightened economic concerns, it gives us reason to be cautious and to prioritise capital strength and balance sheet defences,” he told The Australian.

Investors pushed the share price down 7.6 per cent to $4.01, their lowest since April 24.

For the 12 months through June, revenue slumped more than 50 per cent to $1.13bn, from $2.37bn the year prior.

The investment loss in the second half was compounded by a move to defensive positioning that saw Challenger miss out on the market gains of recent months.

In the wake of the swift market correction in February and March, Challenger Life switched out of its riskier equities and high-yield credit exposures in favour of investment grade credit and fixed income.

It sold $2bn of equities in the third quarter to reduce the portfolio’s capital intensity, locking in the majority of the $341m investment loss it suffered in that asset class.

It also offloaded all of its listed infrastructure assets in the second half after a 25 per cent decline in their valuations.

Half of its investment loss remains unrealised, including a significant portion of the losses it is holding in its fixed income segment, Mr Howes said.

Group assets under management grew 4 per cent to $85.2bn in the year, while normalised net profit before tax was down 8 per cent to $507m. After tax, normalised net profit fell 13 per cent to $344m.

The company’s strategy of growing funds under management and diversifying its revenue base demonstrated underlying business resilience, Mr Howes said, as he sought to reassure shareholders on the outlook for the business.

The rise in funds under management came despite both the fall in markets “and the increased need for our superannuation fund clients to maintain higher levels of liquidity driven by financial market shifts and the federal government’s early release scheme,” he added.

Challenger suffered gross outflows in its funds management business in the March quarter, as well as “significant” redemptions from its life index plus products, he said.

The company declined to pay a final dividend, as foreshadowed in June when it launched a $300m equity raising to strengthen its balance sheet and give it flexibility to enhance earnings.

Mr Howes said he hoped it would be in a position to start paying dividends again in the coming year — and in its target range of between 45 per cent and 50 per cent — but cautioned that this would be dependent on the performance of the company and market conditions.

“We don’t know how this is all going to play out in terms of economic activity. I think governments are doing what they can in order to cushion the economic blow, but that has consequences, both debt loads on balance sheets and on sovereign balance sheets,” he said.

“So there’s an enormous amount of uncertainty, including how long these stimulus measures can last. With all this uncertainty, now is the time to be cautious.”

As it maintains a more defensive portfolio in its life business, the group expects normalised net profit before tax in fiscal 2021 in the range of $390m to $440m.

The immediate drop in the share price likely reflected disappointment in the fiscal 2021 guidance, which came in lower than expected, Shaw & Partners senior analyst Brett Le Mesurier said.

Challenger’s ability to meet its guidance is dependent on it deploying up to $3bn of cash into higher returning investments to generate higher returns, but it warned shareholders that the COVID-19 pandemic could affect the speed of deployment of its capital, and therefore impact guidance.

Mr Le Mesurier raised concerns about its ability to deploy the $3bn given the need for it to remain liquid in the current environment.

“Liquidity is paramount, and therefore the $3bn cash that they have needs to be held on to while liquidity is an issue, which means while outflows are an issue,” he said.

Goldman Sachs analysts, led by Ashley Dalziell, said there were some poorer-quality elements within the result.

The second-half result was mixed, they said, with the life unit’s normalised cash earnings 3 per cent below estimates while funds management income was 7 per cent ahead of expectations.

“With sales composition through the fourth quarter still fairly soft, we expect outlook on this front … will be key to near-term performance,” the analysts wrote in a note to clients.

Total sales in Challenger’s life business grew 13 per cent to $5.2bn in the year but annuity sales were down $400m overall and fell by $900m in the local market. This was driven by structural change in the bank aligned advice networks and changes to means test rules, Challenger said.

The company is strategically focusing its efforts on the independent financial adviser space, Mr Howes said.

The new means testing rules would require a period of adjustment for advisers, it said. In addition, COVID-19 has adversely impacted the ability of advisers to engage with their customers, Challenger cautioned.

Challenger’s share price was hit hard in the market crash earlier this year and has yet to recover.