Why I'm changing my mind about Challenger shares

Three reasons why Challenger is a more compelling stock to invest in now.

| More on:
Three business people join hands in strength and unity

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The Challenger Ltd (ASX: CGF) share price is almost exactly where it was a decade ago. But, it has suffered a lot of volatility during that time. I think it now has a better outlook than I thought.

Challenger is an investment management outfit focused on providing customers with "financial security for a better retirement." It is the largest provider of annuities in Australia.

There are three key reasons why I think Challenger shares could do well as an investment.

Higher interest rates

For me, this is the key difference compared to a few years ago.

There is generally a relationship between central bank interest rates and the return that Challenger offers on some of its key annuities. It's understandable why some people wouldn't want to sign up to a long-term/lifetime annuity if the rate is low.

With the Reserve Bank of Australia (RBA) cash rate now a lot higher than it has been for a long time, Challenger is seeing good demand for its lifetime annuity. In the FY24 first-half result, lifetime annuity sales increased 190% to $1.1 billion.   

The Challenger Life business saw earnings before interest and tax (EBIT) increase 15% to $302 million, and the pre-tax return on equity (ROE) increased 330 basis points to 18.1%.

I think we've entered a new period in which interest rates will remain much higher than they were in the 2010s.

The HY24 result saw normalised net profit before tax (NPBT) grow by 16% to $290 million, while group assets under management (AUM) increased by 18% to $117 billion. Normalised net profit after tax (NPAT) rose 20% to $201 million.

The company expects normalised NPBT to be in the top half of the $555 million to $605 million guidance range.

According to the estimate on Commsec, the Challenger share price is valued at 12x FY24's estimated earnings, which seems like a good valuation consideration profit is expected to grow, and it's exposed to useful tailwinds.

Retirement tailwinds

There are a number of significant trends in the retirement sector.

Challenger referred to Deloitte research that shows Australian superannuation assets are expected to increase from $3.5 trillion today to at least $9 trillion in the next 20 years. There are mandatory (and increasing) contributions, while earnings and contributions are helping the compounding.

The company said that 2.5 million Australians were moving to the retirement phase over the next 10 years, suggesting that the ageing population was a useful tailwind.

Around two thirds of Australian retirees are reportedly concerned with a rising cost of living, and Challenger can help address that worry.

Challenger has a market share of around 88% of annuities in Australia, and that market has grown at a compound annual growth rate (CAGR) of 6% over the past three years.

Plus, the Australian government is progressing a range of reforms to enhance the retirement phase.

Dividend

Challenger has gotten back to growing its dividend for shareholders, which is useful for long-term investors.

According to the estimates on Commsec, the company is projected to pay an annual dividend per share of 25.1 cents in FY24, which would be a grossed-up dividend yield of 5.4%. In FY26, it could pay a grossed-up dividend yield of 6.2% in FY26, according to the projection.

If it can couple a rising dividend with a growing Challenger share price, then it may perform well for shareholders. Having said that, past experience says it won't be a smooth ride.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Challenger. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Opinions

A smiling woman puts fuel into her car at a petrol pump.
Dividend Investing

Where I'd invest $5,000 in ASX shares now for $1,000 of dividend income

The ASX offers a rich hunting ground for dividend income.

Read more »

a man sits back from his laptop computer with both hands behind his head feeling happy to see the Brambles share price moving significantly higher today
Opinions

Why I'd buy this ASX 200 stock (even if we're heading for a market crash)

I am a big fan of this business, which is why I recently invested.

Read more »

A man wearing 70s clothing and a big gold chain around his neck looks a little bit unsure.
Gold

Is it a bad idea to buy ASX gold ETFs at all-time highs?

Some trains shouldn't be caught after they leave the station...

Read more »

a man with hands in pockets and a serious look on his face stares out of an office window onto a landscape of highrise office buildings in an urban landscape
Opinions

Shares vs. property: What $100 invested in 1926 is worth now

AMP chief economist Dr Shane Oliver gives us the answer.

Read more »

A man looks a little perplexed as he holds his hand to his head as if thinking about something as he stands in the aisle of a supermarket.
Opinions

Where I'd invest $5,000 in April 2024

I'd opt for a safer bet with $5,000 this April.

Read more »

A woman sits on sofa pondering a question.
Opinions

Are Coles or Fortescue shares a better buy for dividend income?

Both of these stocks are compelling picks for dividends.

Read more »

A happy boy with his dad dabs like a hero while his father checks his phone.
Growth Shares

2 ASX growth shares that could turn $1,000 into $10,000 by 2034

I think these two stocks have a shot at being 10-baggers.

Read more »

Group of executives meeting around a board table
Opinions

Is it time to put Zip shares back on the table in 2024?

The share price says Zip has its mojo back, but has my mind changed on buying shares?

Read more »