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.
