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

The Challenger Ltd (ASX: CGF) share price has fallen by another 3% today. Considering it has now fallen by over 10% since the report I think it’s worth considering if it’s worth a buy at this price.

As a reminder, here is the main writeup of yesterday’s result announcement.

There wasn’t too much for investors to celebrate with normalised earnings per share (EPS) down by 1% and the dividend up by a meagre 2.9%.

Many of the per-share statistics were hampered by the additional shares that were issued to MS&AD Insurance Group. Challenger’s main guidance of normalised net profit before tax (NPBT) growth of 8% to 12% was only just reached with 8% growth.

There were a couple of economies of scale highlights including a lower cost to income ratio and a higher normalised earnings before interest and tax (EBIT) margin.

Share prices are forward looking, so the market clearly didn’t like what it saw with Challenger’s expectation for NPBT growth of 8% to 12% in FY19. Only time will tell what profit Challenger can deliver next year.

However, my investment thesis for Challenger was never about what it would achieve in FY18. My focus is on what Challenger can achieve over the next decade and beyond.

Challenger is already the leading provider of annuities and guaranteed income solutions in Australia and it has partnered with the leading provider of Australian dollar annuities in Japan.

The total pool of superannuation of assets is expected to double over the next 10 years. In that same time the number of people over 65 is expected to grow by 40%. Over the next 20 years the number of over-65s will increase by 70%. Medical and mortality improvements are improving lifespans, adding greater need for lifelong annuities.

Not only are the number of annuities going to get bigger but the size should increase as well. Australia’s mandatory superannuation contribution is on course to increase to 12% by 2025. Compounding should see current member balances grow bigger and bigger every year.

The government recently announced in the budget that superannuation trustees will be required to offer members an option for guaranteed income. The government is also introducing new means test rules from 1 July 2019. Challenger is the number one in annuities, so it should profit from these changes.

Australia has a very low percentage of assets allocated to fixed income compared to other countries. The UK, USA, the Netherlands and Canada all have around 25% in fixed income whilst Australia is lagging at 10%. If the franking credits system is weakened under a Labor government then annuities could get a boost.

Two likely things that could hurt Challenger in the medium-term are rising interest rates and competition from other fund managers in the retirement income space.

Foolish takeaway

Challenger is not a fast growth share. I don’t expect the share price to do much over the next 12 months. However, trading at 13x FY20’s estimated earnings with significantly more growth beyond that, I think Challenger would make a good buy-and-hold at today’s price. If it drops below $11 I’ll be extremely interested in adding to my position.

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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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