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Is the Challenger Ltd (ASX:CGF) share price a buy?

The Challenger Ltd (ASX: CGF) share price is down by around 15% since its all-time high in December 2017. I think this amount of a drop makes Challenger worthy of consideration whether it’s a buy.

Challenger is Australia’s leading annuity provider which turns a person’s capital in a guaranteed source of income.

Here are my reasons for buying or selling Challenger at the current price:

Buy

Challenger is one business that is highly aligned to the ageing demographics of Australia. People have worked hard all their lives to build up their capital, they might want to keep that money as safe as possible by transferring it into an annuity.

The number of people aged over 65 – retirement age – is expected to grow by 75% over the next two decades. This suggests Challenger’s potential customer base will increase by this amount as well.

Australians may also be about to increase the amount of assets allocated to annuities in retirement. The government recently announced in the budget that all superannuation trustees will need to offer their members a product that provides income for life. Challenger is the clear market leader in this field.

An extra bonus for Challenger is that it’s working with MS Primary in Japan to provide Australian dollar 20 year fixed rate annuities. This was 6% of life sales in the first six months of FY18.

Mandatory superannuation contributions and compound interest will make the annuities bigger over time too, adding to Challenger’s annuity sales.

Sell

The biggest reason why Challenger could be a sell at today’s price is that rising interest rates could have a profound effect over the next couple of years. Most of the assets on Challenger’s balance sheet could suffer in value as rates rise.

It’s hard to say how much Challenger would be affected, but in two years’ time it is quite possible that the fixed interest part of Challenger’s assets will have declined. However, continued high flows of funds into Challenger could make up for this.

Another factor to rising interest rates could be that people are less inclined to lock away their money and instead buy bonds or just put the money in term deposits if it will earn them a satisfactory & safe return.

Foolish takeaway

Challenger is currently trading at 18x FY18’s estimated earnings. This seems like an attractive price/earnings ratio, but it has traded on a cheaper valuation in the past and could yet drop if the problems I wrote about occur in the next year or two. However, I think the current price is very attractive for a decade or longer investment.

However, for now I’m just watching Challenger shares and instead I think these top shares all have a strong chance of providing solid investment returns in FY19.

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Motley Fool contributor Tristan Harrison owns shares of Challenger Limited. The Motley Fool Australia owns shares of and has recommended 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 Scott Phillips.

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