Challenger Ltd increases earnings and announces share placement: Should you buy?

What: This morning annuities provider, Challenger Ltd (ASX: CGF), released its full-year report which showed a 17% drop in statutory profit to $341 million but a 7% increase in normalised profit. “The normalised profit figures are non-statutory amounts and in Challenger’s view better reflect the underlying operating performance of the business,” the company’s full year report stated.

Before reacting to a headline that says something like, “Challenger’s profit drops” I advise you to look a little deeper into the results because they showed some promising long-term figures, including:

  • A final dividend of 13.5 cents per share, taking its full-year payout to 26 cents (management are expecting to pay fully franked dividends in the next 12 months)
  • Normalised earnings per share rose 9% to 64 cents
  • Cash earnings of $425.7 million
  • Record retail annuities sales of $2.8 billion, up 28%, outweighing the reduction in institutional sales
  • Lifetime annuities sales of $613 million
  • Funds Management net flows of $2.1 billion and average funds under management increase of 24% to $44.4 billion
  • Funds management EBIT growth of 27% and pre-tax ROE of 32.8%
  • FY15 Life cash earnings guidance of between $535 million and $545 million

So what: CEO Brian Benari said, “Challenger has recorded five straight years of retail annuity sales growth, and has unambiguous expansion prospects. Lifetime annuity sales growth has been phenomenal, hitting $613 million from only $46 million two years ago. But the post-retirement market remains largely untapped, because this year saw more than $66 billion a year flow from the savings phase to the pension phase of super.”

By 2030, the total amount of funds in Australian super accounts is set to balloon to $6 trillion, from $1.66 trillion in 2013.

Mr Benari commented on the performance of the Funds Management division by saying: “Our Funds Management division more than doubled its earnings over the last two years, and with $50 billion in unfilled investment capacity, we’re now one step closer to our ultimate ambition of becoming a top 5 Australian fund manager.”

Now what: Today’s results won’t go down well with myopic investors but those focused on the long term shouldn’t be disheartened by today’s results in my opinion. Challenger was/is never going to be a business which grows company-wide earnings at 50% per year (does its P/E ratio of just 12 give it away?) but if it does, I’d be concerned.

With the number of retirees set to grow quickly and the fact that there are poor returns on offer from term deposits and savings accounts, management expect the Life division (the division which provides fixed-income annuities) to increase cash earnings strongly in the coming year. Given this and its run up in share price over the past two years, I think Challenger is a hold.

The Share Placement

Challenger also announced a trio of capital management initiatives today. They include:

  1. A $250 million institutional share placement, via a book build (it has requested a trading halt for this to proceed).
  2. An accompanying $30 million Share Purchase Plan offered to retail investors.
  3. A $250 million issue of Challenger Capital Notes.

What does this mean for you?

As investors will know Challenger is like a bank and required by APRA to hold an adequate amount of capital in reserve to guard against a one-in-200-year economic event. This means management want more money in reserve so they can meet capital adequacy requirements and position themselves to deliver suitable products for Australia’s large baby boomer generation.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any mentioned companies. 

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