ASX financial services company Challenger Ltd (ASX: CGF) is expected to grow earnings at a decent clip. In a recent note published by UBS, the broker forecast that Challenger's net profit and dividends could increase by 10% in each of the next two financial years.
So far, Challenger is proving UBS right. In its first half FY25 financial results, released in February, Challenger reported 12% growth in normalised net profit after tax ('NPAT') and reaffirmed its full-year guidance for a 10% uplift in normalised NPAT.
And yet, despite all this good news, the Challenger share price is down almost 11% year-to-date. Its performance over the past 12 months is even worse – shedding close to 20% of its market cap.
Shareholders in the company must be left wondering what more it has to do to get the market's attention.
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How does Challenger make money?
Challenger is a financial services company that sells annuities.
Annuities are financial products that provide a source of regular income in retirement. Retirees can use their superannuation or other savings to purchase an annuity, which guarantees regular payments over the term of the product (which can be either a set number of years or the rest of the purchaser's life). Annuities can help retirees maintain their quality of life throughout retirement, knowing they will be supported in their old age.
Challenger makes a profit by investing the money it gets from its customers. If it can generate a higher return from its investments than it needs to pay to fulfil its annuity obligations, it pockets the difference.
What about the financials?
Despite a 12% fall in annuity sales (to $4.6 billion), normalised NPAT was up 12% to $225 million. Assets under management increased 3% during the half to $131 billion, which allowed the company to grow revenues despite lower sales. Challenger was also able to control its costs very well during the half, increasing its bottom line.
Statutory NPAT – which includes the effects of significant one-off items and accounting valuation changes – rose a whopping 28% to $72 million. The company performed particularly well in Japan, where annuity sales were up 78% to $616 million.
Based on this strong set of results, management reaffirmed its guidance for a full-year normalised NPAT of between $440 million and $480 million. It also declared a fully franked interim dividend of 14.5 cents per share, up 12% from the prior year.
Population demographics are also on Challenger's side. Australia's aging population and robust superannuation industry will provide ongoing tailwinds for Challenger into the future.
Should you invest?
Given its recent performance and strong outlook, it's something of a mystery why Challenger shares have been sold off so heavily recently. Not only does it have growth potential, but it also pays a reliable, fully franked dividend. Based on its current price of $5.38, the stock's dividend yield is an attractive 5.20%.
If you're a value investor, the recent dip in price could present you with a stellar buying opportunity. The market sell-off may now mean that Challenger's stock price doesn't accurately reflect the strength of its underlying fundamentals.
This could present you with an opportunity to profit if the share price increases in line with its intrinsic value. But remember, nothing is guaranteed in the world of share market investing! Always consider the risks associated with any stock before you choose to invest in it.
