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Buy Challenger, not Suncorp

Australian insurance stocks have produced stellar results in the past year thanks to a lack of catastrophe weather events like floods, bushfires and cyclones. Suncorp (ASX: SUN) and Insurance Australia Group (ASX: IAG) have both come out in the past fortnight and provided strong guidance to the market on full-year results.

On Wednesday, Suncorp reported a strong final dividend of 35 cents plus a 20 cent special dividend. However, its bad bank loan sale to Goldman Sachs has caught the market by surprise and investors sold its stocks down almost 3% yesterday. Current prices have built in a higher earnings ratio and it seems investors are expecting solid results in the next two years.

However for this Fool, the stocks are still too expensive to justify a buy. With tougher budgeting requirements for insurance companies operating in Queensland and Australia in general, the certain uncertainty is something I’m not willing to gamble on. The high price, inherent risk associated with insurance stocks and uncertain long term outlook means that Suncorp will remain on the watchlist for now.

A better alternative?

In the half year to 31 December 2012 Challenger (ASX: CGF), an ASX-listed investment management firm that focuses on financial security for retirees, said that by 2030 baby boomers will represent 69% of the retirement population in Australia. We can already see today that Australians are living longer and requiring care and long-term financial security well into retirement.

In addition, Australia’s superannuation has recovered from its pre-GFC levels and surpassed the $1.5 trillion level. This is expected to increase to over $6 trillion by 2030.

Challengers operates two core investment businesses, an APRA regulated life division and a fiduciary Funds management division. As such, stock prices for companies such as Challenger, AMP (ASX: AMP) and Perpetual (ASX: PPT) are highly leveraged to the stock markets. In the past 12 months, Challenger is up 25%, slightly ahead of the S&P/ASX 200’s (ASX: XJO) (Index: ^AXJO) 20%.

sun
Source: Google Finance

Value

In its most recent half year report the company announced a 17% increase in NPAT and confirmed Challenger’s ideal position for the beginning of a 20-year period in which the number of wealthy retirees will increase. However, share prices have lagged.

The company has a market cap of $2.2 billion, $40 billion of FUM, P/E of 7.5 and pays a dividend of 4.5%. Morningstar predicts modest increases in EPS and DPS in the next three years.

Foolish takeaway

In July UBS and Morningstar upgraded their ratings on Challenger. Suncorp’s medium-term outlook looks good, however the shares are fairly priced for any growth. Unless the market presents an opportunity to buy the stock on slightly less multiples, this investor will prefer its smaller rival.

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Motley Fool contributor Owen Raszkiewicz owns shares in Challenger.

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