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Down 6% since the start of May, is the Challenger Ltd share price a buy?

Share prices change every day and unless there’s a huge fall it’s hard to know exactly when to jump on an opportunity.

With Challenger Ltd (ASX: CGF) shares down by 6% since the start of May, is it now a buy?

Challenger is the annuity market leader of Australia and it has a market capitalisation of $7.2 billion. Here are some of the reasons why I’m a shareholder:

Growth of target market

Challenger’s main products are annuities. These provide people with a secure way to turn their capital into a guaranteed source of income.

Retirees are the key target market for annuities and it’s predicted that the number of people over 65 will increase by 75% over the next 20 years. This growth alone will be a big boost to Challenger.

Growth of ways of reaching its market

Challenger distributes most of its annuities through some sort of sales channel.

In recent years Challenger has added CareSuper, LegalSuper and Suncorp Group Ltd (ASX: SUN) among many others as sales channels.

Challenger will soon be distributing through AMP Limited (ASX: AMP) and BT Investment Management Ltd (ASX: BTT) in the first quarter of FY18.

Additional revenue sources

Selling annuities to Australian retirees isn’t the only way that Challenger can boost its revenue and profit in the future. It has also set up a relationship with Japanese financial institution Mitsui Sumitomo (MS Primary).

MS Primary is a huge provider of Australian dollar annuities to Japanese clients. Challenger is issuing 20-year fixed rate annuities to MS Primary.

Although this won’t dominate sales, it could become a sizeable part of Challenger’s business and provide a form of diversification.

Conservative approach

Challenger invests a significant portion of its assets into fixed-income products, which makes its balance sheet quite safe.

It also maintains a conservative dividend payout ratio of around 50% which leaves plenty of money to be reinvested back into the company for future growth.

Risks

There are a number of risks to Challenger. The business and share price is very susceptible to market uncertainty as we are seeing now and in February 2016.

Another risk is that a different financial institution could come along and try to take away market share from Challenger.

In the long-term it may become apparent that Challenger incorrectly calculated how much liability it owed to retirees, or that it didn’t earn enough of a return on its capital. This won’t be known for many years, particularly whilst there is still a large inflow of funds.

Is it a buy?

Challenger is currently trading at 17x FY18’s estimated earnings with a grossed-up dividend yield of 3.8%.

I think Challenger is the best financial stock on the ASX and it is worth being in every investor’s portfolio. It’s hard to say what the right price to pay is, but I expect that the share price will keep growing in the long run.

The current market instability could make now the perfect time to snap up Challenger shares whilst the price is temporarily hit.

Another strong business that's trading at a discounted price, with a much bigger dividend than Challenger, could be an even better investment.

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Motley Fool contributor Tristan Harrison owns shares of Challenger Limited. The Motley Fool Australia owns shares of 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 Bruce Jackson.

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