The business model is clearly challenged under the current environment.
Given interest rates are so low they are forced to hod riskier assets to generate a return for shareholders. The problem is when the risks become a reality the portfolio is not positioned defensively enough to withstand the potential downside and they are forced to realise losses at the bottom of the cycle.
@Klutch
Well said.
This year’s market crash (and subsequent rebound) has highlighted a major element of fragility in CGF’s business model; namely, the fact that their Risk Management policy is not robust enough to keep the Company well-capitalised through a sufficiently wide range of capital market scenarios, without the need for an eventual capital injection to avoid EPS dilution.
Adopting a simple equity collar strategy on just 30% of the Life Equity Portfolio, which is basically all the Company had done to hedge their market exposure, has hardly made any difference in terms of limiting their downside and protecting their capital adequacy ratios, without the need for further intervention.
By way of comparison, some US life insurers (who are also annuity providers) in the March quarter reported hedging gains (from equity and interest-rate derivatives) that were bigger than their entire Market Cap, which allowed them to 1) avoid raising equity, and 2) avoid locking in large losses by repositioning their investment portfolio at just the wrong time.
I find it slightly pathetic that CGF Management are now pitching this CR to shareholders as a way of capturing investment opportunities with a higher ROE than their Group target, when their portfolio repositioning essentially consisted of selling very similar securities at prices that implied an even higher ROE.
Why not just say “sorry, we got it wrong and now need your help to compensate for the loss we had to lock in”, as that is basically what this CR is for. The fact that MS&AD have decided not to participate in the raising, despite the CR price being a lot lower than their average cost base, speaks volumes as to how this whole situation has been managed.
As to whether or not I see it rational to take part in the SPP, the way I am looking at it is as follows:
a) As the current Net Assets per share is 4.80$ (pre-CR, see slide 21 of today’s presentation), participating in the CR at a price of 4.89$ means paying a small premium to Book Value.
b) The current FY20 normalised earnings guidance (which excludes the impact of market losses, even those that have been locked in) implies a post-tax ROE of 11.0%-12.0%; I am personally skeptical of Management’s ability to sustainably increase that ROE by simply re-risking their Investment Portfolio, in an environment characterised by downward pressure on rents, dividends and infrastructure distributions (and quite possibly by an increase in credit defaults).
c) I also note that CGF’s negative Investment Experience as of May 31st was -847m$, whereas the implied drop in CET1 between December 31st and March 30th was -811m$ (see https://hotcopper.com.au/posts/44222492/single); therefore, it doesn’t even look like CGF have noticeably benefitted from the market rebound so far, despite leaving ~50% of their losses unrealised.
d) Given the prevailing level of valuations in the financials/insurance sector (within and outside Australia), paying above Book Value for a 11.0%-12.0% ROE business, which is actually more like 8.0%-8.5% once the ~140m$ pa of Normalised Capital Growth has been removed, does not look particularly compelling to me.
So, my overall conclusion is that I am going to pass, on this SPP.
All IMHO, DYOR, and all the usual disclaimers apply.
Cheers
(20min delay)