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Morningstar | Aristocrat Earnings to Benefit from Lower Australian Dollar and Ongoing Investment into Digital

We raise our fair value estimate for Aristocrat Leisure by 4% to AUD 24.50 per share, to reflect the translation benefit of the lower Australian dollar relative to the U.S. dollar, and time value of money. We have adjusted our currency assumptions to AUD/USD 0.71 from 0.73 for the next five years and given most group earnings are generated in U.S. dollars, the impact on our earnings forecasts is notable. The lower Australian dollar increases our EPS forecasts by around 3%, although this is partially offset by softer near-term margins in the digital business. We have lifted our EPS forecasts by 1% on average during fiscal 2019-2021 to AUD 1.36, AUD 1.54, and AUD 1.72, respectively. After rebounding by almost 20% since the start of calendar 2019, shares in Aristocrat Leisure are fairly valued relative to our revised fair value estimate. We continue to believe the firm benefits from a narrow economic moat, supported by intangible assets, most noteworthy being its licences to distribute slot machines in many parts of the world and its intellectual property.

Despite only accounting for one fourth of fiscal 2019 earnings, digital is likely to remain the fastest-growing segment for at least the next five years. Based on our projections, digital will represent over 35% of group earnings within the next five years. The casual game and social casino market (which make up the bulk of digital earnings) are growing at a low-double-digit pace. We project Aristocrat will grow slightly faster, supported by new game releases, and an additional AUD 100 million investment into user acquisition during fiscal 2019.

The benefits from the initial digital user acquisition investment are likely to take approximately four to five months to materialise and therefore will be skewed to the second half of fiscal 2019 and beyond. The firm has indicated user acquisition, or UA, investment is likely to remain at between 25% and 28% of digital revenue for the foreseeable future, which should help sustain low-double-digit digital revenue growth on average during the next five years. While the initial UA investment is likely to result in temporary margin compression during fiscal 2019, we forecast digital margins can increase by around 200 basis points from current levels to approximately 34% by fiscal 2023.

We continue to believe the firm's slot machine ship-share in the mature Australian market has peaked and should remain stable at approximately 60%. Strong sales of the top performing games Dragon Cash and Dragon Link will support this leading position for the next few years, while maintaining industry-leading selling prices. The earnings base should become more stable as the company continues to transition customers to its new fee per day product, which allows customers to choose between a wide range of game content on a subscription basis.

We forecast the company to continue increasing design and development investment across the land-based gaming portfolio (in dollar terms), albeit maintaining at between 11% and 12% of group sales. We project Aristocrat's North American ship-share (share of outright machine sales) to reach 25% within the next five years, up from the current estimated 21%. These gains will be incremental in nature, compared with the accelerated growth during the past three years, and will be supported by expansion into adjacent segments growing the addressable market.

The North American class III premium gaming operations installed base (leased machines) will also continue growing strongly for the next few years. With a suite of top performing games, the firm should be able to continue to expand its market share, and we forecast it will be over 45% by fiscal 2022, compared with the current 33%. This is likely to be driven by further penetration of its suite of top performing products along with a broadening of the existing game portfolio, while maintaining market-leading fee per day performance across the entire installed base.