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Why Challenger just posted a 97% decline in half year profit

The Challenger Ltd (ASX: CGF) share price will be on watch on Tuesday following the release of its half year results this morning.

Although much of the result was pre-announced and is the reason the Challenger share price is down 17.5% year to date, there was some important new information released by management.

How did Challenger perform in the first half?

For the six months ending December 31, Challenger generated revenue of $893.5 million and net profit after tax of $6.1 million. This was a decline of 20.8% and 96.9%, respectively, on the prior corresponding period.

The company’s net profit was lower than the prior corresponding period due largely to valuation movements on assets and liabilities supporting the Life business. Excluding this from its result, Challenger’s normalised net profit after tax was down just 3.9% to $199.8 million.

A fully franked interim dividend of 17.5 cents per share was declared by the Challenger board.

Challenger chief executive officer, Richard Howes, described the first half as challenging, but remains confident that the company is well positioned to capture opportunities for future growth.

He said: “Our results for the first half have clearly been impacted by the difficult operating environment we’re experiencing, with increased market volatility, industry disruption and political uncertainty playing out across the sector. While some of these factors are beyond our control, the fundamentals underpinning our business remain supportive. We continue to target a growing market of retirees, we have the leading retirement income brand in the country and our capital position remains very strong.”

What were the drivers of the result?

The Challenger Life business posted cash operating earnings (COE) of $330 million, down 2% on the prior corresponding period. During the half the company grew its Life book by 4.2% to a record $14.5 billion, driven by solid domestic sales and a lower maturity rate.

However, this was offset by a 7% decline in total annuity sales to $2.1 billion. This was caused by a decline in Japan sales, which were down 55% due to higher US interest rates relative to Australia reducing demand for Australian dollar products in Japan. Domestic annuity sales grew 4% with Lifetime sales up 5%.

This ultimately meant that total Life sales were down slightly on the prior corresponding period to $2.7 billion.

Elsewhere, the Funds Management business’ average funds under management increased 9% to $77.4 billion, with Fidante Partners up 8% and Challenger Investment Partners up 11%. However, net flows were -$1 billion due to a large Australian institutional fixed income mandate redemption.

The business was also impacted by market conditions resulting in lower performance fees in the period.

What now?

Management appears optimistic that it is well positioned to take advantage of the broad demographic tailwinds behind Australia’s growing retirement income market.

It has expanded its distribution reach through the Westpac Banking Corp (ASX: WBC) BT Panorama platform and plans to launch on platforms operated by HUB24 Ltd (ASX: HUB) and Netwealth Group Ltd (ASX: NWL) in the second half.

Outlook.

Challenger continues to expect FY 2019 normalised net profit before tax to be between $545 million and $565 million.

It also reiterated that it does not expect to reach its 18% normalised return on equity before tax target this year due to lower earnings.

Should you invest?

Although I can see that there is a very big market opportunity for Challenger, I’m not a big fan of the company right now and would suggest investors wait to see if its performance improves in the second half before considering an investment.

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Motley Fool contributor James Mickleboro owns shares of Westpac Banking. The Motley Fool Australia owns shares of and has recommended Challenger Limited. The Motley Fool Australia owns shares of Netwealth. 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.

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