The Challenger Ltd (ASX: CGF) share price has grown by 17.6% since the start of 2017. Shareholders can be very happy with that, but I think there could be a lot more to come over the next several years.
Challenger is Australia's leading provider of annuities with a dominant market share. I think the business could grow strongly because of the following reasons:
Growth of distribution channels
Challenger gains access to more potential clients through its distribution network. The more channels it opens, the more annuities it can sell.
For example, in FY17 Colonial First State, CareSuper and LegalSuper all started offering Challenger annuities. In the first quarter of FY18 annuities will be sold through AMP Limited (ASX: AMP) and BT Investment Management Ltd (ASX: BTT).
Even though Challenger is already the market leader, there is a lot of untapped potential until all possible distribution channels have been opened.
Growth of target demographic
Every year that passes results in more hard-working individuals reaching retirement age. It's in this retirement period where Challenger's product is best suited.
An annuity can provide a retiree with guaranteed income, providing certainty for their capital and income.
The number of retirees is expected to substantially increase over the next two decades, greatly increasing Challenger's target market.
Financial advisers in their droves are suggesting their clients take up an annuity. Annuity sales grew by 53% in the quarter to 31 March 2017 compared to the prior corresponding period.
Partnership with Mitsui Sumitomo
Challenger has also created a relationship with Japanese business Mitsui Sumitomo, which is a large and established provider of Australian dollar (AUD) annuities for Japanese clients. Challenger is issuing 20-year AUD fixed rate annuities to Mitsui Sumitomo.
This is not a large part of sales (yet), but after only a few months the signs are positive that this could turn into a sizeable part of Challenger's business in the years to come.
Risks
Challenger will be susceptible to interest rate movements for a variety of reasons, so investors should be aware of the global rise of interest rates.
It's also exposed to any large market movements, such as in February 2016, because it's a financial stock with large funds under management.
The longer-term risk is the possibility that Challenger hasn't allocated enough money for future payments to retirees, but this can't be known for a number of years.
Foolish takeaway
Challenger is trading at 20x FY17'S estimated earnings with a grossed-up dividend yield of 3.62%. I think this is still a very reasonable price considering how much it is expected to grow in the decade ahead.
The amount of money entering the retirement phase is going to grow strongly over the coming years and I expect Challenger will grow strongly too.
