Income Report / Income Note: A review of the new Challenger Financial Hybrid

By Market Matters 14 October 20

Income Note: A review of the new Challenger Financial Hybrid

The market is taking a breather today after a strong period with the ASX 200 trading back to the top of its trading range, around the 6200 handle. Futures were implying more weakness this morning, however some resilience is obvious and as I wrote this AM, my “Gut Feel” is the market is due a rest, at least for a few sessions, but the surprises are still likely to be in the direction of the trend which since March is clearly up.

I was chatting with Alan Kohler this morning about 1. The Adore Beauty IPO where he was asking about demand given a ‘ridiculous valuation’ based on current earnings then 2. About the broader market and what’s driving it. In terms of the Adore Beauty IPO, it’s getting some press based on valuation, it’s eye wateringly expensive on an earnings multiple however important to remember that they’re reinvesting heavily for growth, which depresses earnings. If you can grow the top line at 70% as they have done, spending money to take advantage of that trend makes sense. That said, the valuation is not lost on me, it’s expensive, however I think its justified, and probably best to not look at earnings for a while! In terms of point 2, supportive central banks + governments are obviously a very helpful factor in all of this, a point I made on Alan’s Podcast.  

Overall, the ASX 200 is currently trading down -10pts / 0.18% to 5184.

ASX 200 Chart

The Income portfolio performed well over the last week, tracking equity markets higher by adding 1.70%. NAB & Wesfarmers (WES) were up over 6% in the week, while Smart Group (SQ) was 5.62% higher. The portfolio remains well ahead of its benchmark for the current financial year, currently up 5.98% vs the RBA + 4% target of 1.21%.

Z1P Co (Z1P): Trading down around 4% at time of writing  after releasing their 1Q21 trading update.  The results were broadly in-line with expectations and supports the view that QuadPay is likely the fastest growing US BNPL provider and that the growth is ramping into the seasonally strongest period.Z1Pcustomers now sit at 4.5m – up +96% YoY with more than 7k new customers per day being added. The weakness today looks overdone given the trends reported, it seems like there is some rotation going on into larger rival AfterPay (APT) after they had a favourable ruling from Austrac today, the regulator deciding that it would not take any further regulatory action after they’d previously found issues with regards to various reporting obligations under the AML/CTF act. While this wasn’t a big overhang, its still a win for the company hence some rotation from Z1P to APT.

MM still prefer Z1P although remain bullish both.

Z1P Co (Z1P) Chart

CGF Hybrid (CGFPC) – New offer

This week Challenger have launched a new hybrid investment to help re-pay the existing CGFPA on issue. The $250m raise is comprised of a re-investment offer (for the CGFPA that had been scheduled to be called in May of this year before COVID took hold) plus a new money offer. The deal opened this week and will close shortly, a quick turnaround implying that demand has been strong into the new money component.

Challenger is a slightly more complicated entity than some and is considered at the higher end of the risk spectrum for Hybrids – inline with issuers like AMP.

The structure of the issue is a typical tier 1 security, the same structure as the CGFPA that its replacing and the CGFPB which remains on issue.  Existing CGFPA holders have three options, 1. Tender to have all CGFPA holdings repurchased for cash at face value ($100) under the Repurchase Invitation 2. reinvest some or all CGFPA holdings into the new security under the Reinvestment Offer or 3. take no action to continue holding CGFPA.

The yield on offer is 4.60-4.80% over the 90 day bank bill rate which equates to 4.68-4.88% with first optional call date on the 25th May 2026. Given demand, it will come in at the lower end of the range.

Looking at existing securities on offer, the rate (at the bottom end) is about 1.4% above similar sorts of major bank hybrids (think of it as a 1.4% risk premium), it’s less than the AMPPB which has 5.2 years to first call trading on 5.24% over bank bill, but better than the CGFPB at 4.30%, although that only has 2.6 years to first call.

All up, this is a higher risk security in the context of hybrids, however the compensation is there for that risk.

MM is positive on the CGFPC.

Challenger Group Financial (CGF) Chart

Conclusion

MM remain positive Z1P

MM are positive the new CGF Hybrid

Disclosure

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