Is the Challenger Ltd (ASX: CGF) share price a buy?

Investors were thrown a curve ball today after the annuity business announced a capital raising.

The capital raising part of the announcement

Here are the details of the raising. 

The first part of the raising comprises a fully underwritten institutional placement of $270 million. The second part is a non-underwritten share purchase plan (SPP) which is looking to raise up to $30 million.

The placement will be conducted at a fixed price of $4.89 per new share, which represents an 8.1% discount to the last traded price of $5.32 and a 5.7% discount to the volume weighted average price (VWAP) of Challenger shares traded on the ASX during the five days leading up to 19 June 2020.

The placement will mean 55 million new shares will be issued. This is approximately 9% of Challenger’s existing shares on issue.

Eligible retail shareholders can apply for up to $30,000 of new Challenger shares. The price will either be the Challenger placement share price of $4.89 or a 2% discount to the weighted average share price in the five days up to the closing date of the share purchase plan (being 21 July 2020).

According to reporting by the Australian Financial Review, the $270 million placement was covered by institutional investors by early afternoon.

MS&AD, Challenger’s major shareholder and strategic partner, has said that it won’t be participating in the capital raising. The investor said it supports the raising and remains committed to its strategic relationship and will remain a major shareholder.

I think it’s a shame this raising is being done at a much lower share price compared to a few months ago. This is the case for many businesses doing capital raisings during this period. 

The dividend part of the announcement

As part of the capital raising, Challenger said: “Given the uncertain economic conditions, investment market volatility and intention to maintain a strong capital position while optimising earnings, the board’s intention is that no final FY20 dividend will be paid by Challenger in September 2020.”

This is very disappointing. Of course, it wouldn’t make sense to do a capital raising and then pay out a large dividend a few months later. That would be dilutive for shareholders and the Challenger share price. 

However, before this announcement, Challenger had a reliable dividend record that went back further than the GFC with no cuts. This decision ends that streak. 

Challenger may well bring back a pleasing dividend in FY21. But I don’t think it can be called a reliable dividend share any more.

What will Challenger do with the raised capital?

The equity raise will strengthen Challenger Life’s capital position during this period of market uncertainty, with $300 million to be used as common equity tier 1 (CET1) regulatory capital.

Challenger said that investment grade fixed income asset risk premiums have widened significantly following the COVID-19 pandemic market sell-off. The annuity company thinks that there is a significant opportunity to generate pre-tax return on equity (ROE) returns of more than 20% on the capital backing the investments. The capital will be progressively deployed and expected to be ROE accretive once fully deployed.

Is Challenger a buy at this share price?

The company is expecting normalised profit before tax to be at the bottom end of its $500 million to $550 million guidance range. However, the statutory net profit after tax (NPAT) is expected to be impacted by the market sell-off. At the end of May 2020, it’s showing a loss of $483 million for FY20 to date.

I see why Challenger is doing the capital raising, particularly for boosting Challenger Life’s CET1 ratio. The prospect of earning strong ROE returns is also alluring.

The capital raising price does look attractive for eligible shareholders and Challenger may be cheap. But the cancellation of the final FY20 dividend makes Challenger less appealing to me now. Will a solid dividend return? Investors will have to hope that Challenger is able to utilise the new funds in a very effective manner to make up for the lost dividend income. The last couple of years have been disappointing for Challenger shareholders.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Challenger Limited. 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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The Austal Limited (ASX: ASB) share price has surged 9.52% today after the shipbuilder announced a US$50 million agreement with the US Government. The US Department of Defense has entered into an agreement with Austal to maintain and protect its domestic shipbuilding and maintenance capacity.  

What does Austal do?

Austal is a shipbuilder that designs, constructs, and supports defence and commercial vessels. The company produces high speed passenger ferries and passenger-vehicle ferries, as well as frigates, high speed military transport vessels and patrol boats. Austal operates from shipyards across the US, Western Australia, Vietnam, and the Philippines.

What does the new agreement mean?

The new agreement is part of the US Government’s national response to COVID-19 and aims to protect and expand critical domestic shipbuilding capacity. Austal intends to use the funds to invest in the development of additional capacity for steel naval vessel construction at its shipyard in Mobile, Alabama.

Austal says it is likely to match the US$50 million investment, bringing the total investment to around US$100 million. The company reports that this should benefit US Navy shipbuilding and accelerate pandemic recovery efforts in the Gulf Coast region.

How has Austal been performing?

The Austal share price was crunched in the March correction, falling 47% to $2.31 at its lowest. Since then the Austal share price has regained much of this ground, with shares currently trading at $3.68. The Austal share price was also boosted by upgraded guidance last month along with a US$43 million contract modification last week.

In May, Austal increased its FY20 earnings guidance to group revenue of approximately $2 billion and group earnings before interest and tax of no less than $125 million (up from $110 million). The upgraded guidance was issued as a result of COVID-19 having a more limited impact on performance than anticipated, along with the sustained strength of the US dollar, and the award of a new vessel construction contract announced in May.

Commenting on the upgraded guidance, Austal CEO David Singleton said: “Austal’s continued strong performance across our shipyards in the USA, Australia, Philippines, and Vietnam during the COVID-19 pandemic has provided confidence to increase the Company’s FY2020 earnings guidance.”

In 1H FY20, Austal reported a 22% increase in revenue which reached $1.04 billion. The shipbuilder made a net profit after tax of $40.8 million, up 72% on the prior corresponding period. Austal finished the half with net cash of $152.4 million.

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Motley Fool contributor Kate O’Brien has no position in any of the shares mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of Austal Limited. The Motley Fool Australia has no position in any of the stocks mentioned. 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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