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Why Credit Suisse just slapped an outperform rating on Challenger Group Ltd shares

Financial news wires are reporting that top research house Credit Suisse has slapped an outperform rating and bullish $12 share price target on annuities provider Challenger Ltd (ASX: CGF).

I must admit I agree with the team at Credit Suisse on this one as Challenger looks one of the better stocks on the ASX for investors chasing the wealth builder’s elixir of growth and income.

As an annuities provider to the baby boomer generation it’s no secret that Challenger has some powerful tailwinds via ballooning superannuation balances and government support in shifting pension liabilities onto the private sector whichever way possible.

Of course tailwinds mean nothing in investing unless a company is able to harness them and has a business model with a decent moat to protect its profit-growing potential.

In this regard Challenger looks to tick the boxes as it’s the dominant annuities provider in Australia with strangely little competition and its widening distribution networks also look set to support medium-term growth.

Last October it announced it had signed distribution agreements with powerful investment administrator AMP Limited (ASX: AMP) alongside giant Japanese life insurance business Mitsui Sumitomo. The Japanese market is one made in heaven for a business like Challenger, given Japan has a large population where citizens have high savings rates and record-breaking life expectancies.

Challenger already has distribution agreements with most of the other main wealth-planning businesses in Australia like Suncorp Group Ltd (ASX: SUN) and Colonial First State as the wealth management and distribution platform of the Commonwealth Bank of Australia (ASX: CBA).

The kicker is that annuity sales are growing at stunning rates with “lifetime” annuity sales more than tripling on the prior corresponding quarter (pcq) for the quarter ending September 30 2016. While the more popular term annuity sales were up 21% over the pcq. Overall annuity sales for the most recent period were up an impressive 46% on the pcq.

This is the kind of accelerating growth I like to see in a business that is now forecasting normalised cash operating earnigns of $620 million to $640 million for the full year.

A key risk is its balance sheet management as Challenger has long-term liabilities to its clients and a significantly changing macro environment could pressure margins as it seeks to earn margin-enhancing returns on its investment portfolio.

Even if annuity margins come under pressure it has room to cut costs and it remains conservatively capitalised as a regulated insurance business under the prudential regulator’s (APRA) rules.

Is it a buy?

Selling for $10.90 the stock looks good value in my opinion on around 17x analysts’ estimates for earnings per share of 64 cents in FY 2017. This stock’s attraction at current levels is enhanced by an expected fully franked dividend yield of more than 3%, a recent history of strong annuity sales growth and the aforementioned tailwinds.

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Motley Fool contributor Tom Richardson owns shares of Challenger Limited. T

You can find Tom on Twitter @tommyr345

he 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.

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