Financial services business Challenger Ltd (ASX: CGF) today posted a normalised profit of $182 million for the six-month period ending December 31 2015 as it benefited from assets under management growth and improving margins.

The group operates separate funds management and annuity businesses, with underlying annuity sales up 10% on the first half of 2015, while the funds management business grew assets 15% on the prior corresponding period (pcp), when adjusting for the sale of Kapstream Capital in July 2015.

The highlight of the result is the disciplined expense management as the group’s cost to income ratio dropped 60 basis points to a low 33.8%, which is likely a reflection of the high-margin nature of the dominant annuities business and its attractive economics.

Annuities as the crown jewel

Given Australia’s baby boomer population is increasingly focused on retirement products the group’s annuities business remains its dominant growth driver, with the powerful tailwind of ever-expanding average life expectancies, backed up by a market-leading product.

For the period the annuities business posted earnings of $249 million, up an impressive 15% over the pcp, with a 1.3% improvement in the cost to income ratio that was 33.8%.

Average assets under management also grew 12% on the pcp to $13 billion and growing revenues much faster than costs is a potent growth cocktail that has helped drive the stock’s price 6% higher over the past year, despite a 22% decline in 2016 in tandem with the general plunge in equity markets.

Funds Management

Average fund managers will have far higher cost to income ratios than an annuities business and Challenger’s funds management business remains leveraged to the general strength of global capital and equity markets in particular. Challenger’s funds business posted earnings of just $22 million for the period, which emphasises just how dominant its annuities business has become as the growth driver.

Outlook

The group reaffirmed guidance for its annuities business to post operating earnings of $585 million to $595 million for the full year and expects to maintain a fully franked dividend payout ratio of 45%-50% of normalised profit. Return on equity was 18%, up 17% on the prior half as the cost disciplines continue to improve the earnings growth prospects.

Selling for $6.86 the group trades on just 10x an annualised amount of normalised earnings per share, with an attractive estimated yield in the region of 4.7%. Challenger shares look a buy given the stock’s valuation, and the group’s leverage to the aging population and attractive margins.

BRAND NEW! Our Top Dividend Stock for 2016

Our resident dividend expert names his Top Dividend Share for 2016. Not only are the shares dirt cheap, the company is trading on a 5.6% fully franked dividend yield. Simply click here to gain access to this comprehensive FREE investment report, including the name of this fast growing ASX dividend share. No credit card required!

HOT OFF THE PRESSES: Motley Fool’s #1 Dividend Pick for 2017!

With its shares up 155% in just the last five years, this ‘under the radar’ consumer favourite is both a hot growth stock AND our expert’s #1 dividend pick for 2017. Now we’re pulling back the curtain for you... And all you have to do to discover the name, code and a full analysis is enter your email below!

Simply enter your email now to receive your copy of our brand-new FREE report, “The Motley Fool’s Top Dividend Stock for 2017.”

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our https://www.fool.com.au/financial-services-guide">Financial Services Guide (FSG) for more information.

Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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 Bruce Jackson.