Is the Challenger Ltd (ASX: CGF) share price a buy for its grossed-up dividend yield? It might be.
What has happened to Challenger?
Challenger has seen its share price fall by 55% since the market started dropping from 21 February 2020 due to the coronavirus. That's one of the most painful falls among the larger businesses on the ASX. It hasn't quite recovered to the same level as plenty of other shares have done. Financial shares seem to be among the worst hit.
But Challenger doesn't face the same problems that banks like Westpac Banking Corp (ASX: WBC) do. There aren't billions upon billions of potential bad debts. There isn't a large impending AUSTRAC penalty.
However, there are at least a couple of factors that somewhat justifies Challenger's share price decline.
The first is that it has a very large balance sheet. Its assets under management (AUM) dropped by 8% over the March 2020 quarter – that means lower management fees for the business, and also hurts the company with it paying guaranteed income to clients at an unchanged level. AUM may not be that quick to climb again with superannuation contributions likely to be lower this year and people able to withdraw some superannuation money.
The second big issue is that ultra-low interest rates are not good for generating sustainable returns. Challenger has shifted more of its assets into fixed income. It protects against the downside but the actual returns produced by fixed income is very low.
But there are positives too for the Challenger share price. The company has continued to sell a solid amount of annuities in the third quarter of FY20, with total Life sales up 9% on the prior corresponding period. And people may be seeking safety after this market volatility.
Is the Challenger share price a buy for dividends?
Pleasingly, the company reaffirmed its guidance for normalised net profit before tax to be between $500 million and $550 million. That will hopefully mean that Challenger can continue to pay an annual dividend of 35.5 cents per share, which equates to the 11% dividend yield. This will support the Challenger share price.
It managed to maintain its dividend during the GFC and I think it could continue to do so, though of course there's a chance a cut or deferral may happen. It could be a solid medium-term buy at this price, though very low interest rates could be bad for long-term.
