Challenger: Good story but fully valued

Morgans Financial Limited

We like the CGF story in the longer term and think management has done an excellent job opening up growth opportunities for the company. We lift FY17/FY18F EPS by ~1-2%. Changes to our numbers reflect a slight increase in net book growth assumptions which have offset lower COE margin forecasts. However, with CGF having re-rated strongly over the past 12 months, it is now more fully valued trading on 18x FY17F earnings. We also think significant expectations are now built into the current share price and therefore we maintain our Hold recommendation.

Some clear positives

Overall the 1H17 CGF result was relatively solid, in our view. 1H17 normalised NPAT of A$197m was ~2% above Bloomberg consensus of A$194m (Morgans estimate A$190m). Life cash operating earnings (COE) of A$316m were broadly in the middle of management’s re-affirmed FY17 guidance range (A$620m to A$640m).

While 2Q17 retail annuity sales growth of 25% slowed on 1Q17 (~46%), it was still impressive, including A$125m in sales in just two months from the recently announced MS Primary relationship in Japan.

CGF also unveiled a further two new distribution relationships with BT Financial Group and Standard Life.

Average new annuity tenor improved to 8.7 years (1H16: 5.6 years), with longer term annuities (including MS Primary sales) now representing 31% of total annuity sales (1H16: 14%). Finally the group cost to income ratio fell 90bps on pcp to 32.9% on improved efficiency outcomes.

Where was there weakness?

We saw a couple of areas of softness in the result. Firstly CGF’s life COE margin declined by about ~2% on 2H16, removing a one-off benefit (A$10m).

This decline is marginally larger than we expected, although on an underlying basis the product margin was stable, with the impacts being from lower shareholder funds/capital growth as flagged by management.

The second area of result weakness was the decline in the CLC excess capital position from A$1.01bn to A$772m in the half. While CGF indicated ~A$183m of this decline was due to “one off” impacts, we see CLC’s current CET1 ratio of 1.09x as only reasonable. Furthermore, we think this ratio could face additional pressure going forward, given a focus on selling longer dated annuities, which could increase new business strain or require more growth assets to support the book.

Contributed by: Richard Coles, Senior Analyst, Insurance and Diversified Financials: Original blog here: (VIEW LINK)


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