Is this result a sign of a brighter future?

Even with a reported 21% jump to underlying net profit for the first half of the year, Challenger's (ASX: CGF) share price still slid slightly to $6.27 before rebounding to $6.80. 

For Allan Gray's Simon Mawhinney, the market response was a surprise given that both the company's funds management and and life and annuities businesses had grown strongly, putting its group assets under management to $115 billion, a 20% lift. 

"Their funds management business seems to have grown in an environment where other insurance management businesses have actually had significant outflows. 
"I’ve been surprised by the extent the annuity book has grown. Annuity businesses are very capital intensive businesses."

In a stream of positives, Challenger also reaffirmed it guidance for the full year, and announced that it would pay a 11.5 dividend, up 21%. 

In this Q&A, Mawhinney outlines his views on the company's bright future - and Challenger's increasing competitiveness in the space. 

Challenger's reporting results 1H22:

Source: Challenger 1H22 presentation

Edited transcript

What are the key takeaways from Challenger's result?

Mawhinney: The key takeaways were that their funds management business seems to have grown in an environment where other insurance management businesses have actually had significant outflows, so I'd say that comendable. Their Life book has also grown reasonably strongly without too much margin compression, a good result. 

What did you think of the market's reaction? Was it an underreaction, overreaction or appropriate?

Well initially the market sold the shares off which I was astonished with. When last I looked it had moved higher. I think it's a good result, but it takes time for people (including ourselves) to digest these results, and I think that digestion will manifest itself in a price over the coming weeks. Let's see what happens. 

I think the bigger factor in Challenger is value, and about what happens with interest rates going forward, ie. how much of the pie they can essentially capture, because they're a spread business. As much as interest rates rise, the same as everyone seems to think for the banks, it's quite possible that Challenger will be able to capture a similar or greater percentage of the pie but a greater dollar amount. That should really help with their earnings, but if anything it's a tailwind rather than a headwind in that they've been experiencing headwinds for a number of years. 

And there's some legislation and regulatory outcomes which might also offer tailwinds from here, like the retirement income covenant tests. There are so many things which can move in and out of favour for one company, but in Challenger's case it does seem that the future looks a little bit brighter than the immediate past. 

Were there any surprises in the result investors should be aware of?

It's only been positive surprises, but I’ve been surprised by the extent the annuity book has grown, around 8% I think. That’s my biggest surprise in that it’s good and bad. Annuity businesses are very capital intensive businesses, and it’s not like you’re getting these returns for free. They’re having to invest some of our capital to grow their annuity book. But again, it’s not dissimilar to the way banks work.

I was pleased with the investment experience outcome. Challenger has been notorious for significantly negative investment experience over the years. Here you have a statutory result that’s quite a lot better than the underlying result, which is good but reflective of the very significant asset price inflation that we’ve seen.

What are your expectations and outlook for Challenger and the wider industry? 

I guess this is the big unknown: I think it's quite possible that the industry as a whole experiences significantly more growth in the years ahead than it has in the past, and that in isolation is a good thing. But industries that grow very strongly attract more competition, and that would be a bad thing. 

Where those two things meet is anyone's guess. 

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