EUR 850.00 For Business Accounts Only

Morningstar | Strong Momentum in North America Drives Another Solid Result for Aristocrat Leisure. See Updated Analyst Note from 23 May 2019

Narrow-moat Aristocrat Leisure’s strong momentum in North America shows no signs of slowing. This was evidenced by the solid market share gains achieved in the (leased) gaming operations and outright unit sales categories, in the first half of fiscal 2019. The firm reported a 17% increase in interim earnings per share (pre-amortisation), or EPSA, to AUD 66.2 cents. However, part of this growth reflected the translation benefit of the weaker Australian dollar. Excluding the currency tailwind, EPSA rose by about 8% compared with the prior corresponding period. We have raised our fiscal 2019 full-year EPSA forecast by 3% to AUD 1.39 per share, a 22% increase on fiscal 2018, to reflect the stronger-than-expected North American performance and second-half skew of digital.

We raise our fair value estimate by 7% to AUD 26.00 per share, reflecting the following: (1) lower Australian dollar (we lower our long-term AUD/USD assumption to AUD 0.70 from AUD 0.71) as the increasing likelihood of domestic interest rate cuts will weigh on the Australian dollar relative to the US dollar, (2) accelerated market share gains in North America, particularly in the resilient gaming operations category, and (3) the lower effective tax rate, which is expected to fall 100-150 basis points to about 26% from fiscal 2020 onwards. This reflects the increasing portion of Aristocrat’s earnings generated from the United States. Our EPS projections will increase by 4% on average over the next five years, and we forecast an average annual growth rate of 14%. The shares remain slightly overvalued relative to our revised fair value estimate.

The digital segment is becoming increasingly important, and after growing revenue and EBITDA by 37% and 17% respectively, in the first half of fiscal 2019, it now represents over one third of total group revenue, and over a quarter of group earnings. However, this jump primarily reflected the first full period contribution from the recently acquired Plarium and Big Fish businesses. On a pro-forma basis, revenue rose by a more modest 2%, whereas EBIT would’ve declined by 7%. We are unconcerned by the softer digital margin, as this is mainly an outcome of the additional expenditure on marketing and user acquisition (up 46% on last year), along with new game launches. This is consistent with the firm’s strategy of growing the user base and increasing scale. The pipeline of new games is strong, and this investment should pay off in the coming years and support low-double-digit top line growth in digital for at least the next few years. We think the current 30% is the bottom for digital EBIT margins and given the high degree of operating leverage this should stretch to approximately 35% longer term.

Whilst we had forecast the company to continue capturing additional market share in North American outright machine sales, it has exceeded our expectations by already reaching our long-term ship-share target of approximately 25%. This reflects entry into adjacent product categories and success of the Helix cabinets and a suite of top performing games. We now see the firm’s market share reaching 30% by fiscal 2023, a level which we believe can be sustained by the ongoing commitment to game design and development, or D&D, expenditure. During the first half D&D increased by one third, and we forecast it to continue rising in dollar terms, albeit steady at around 11.5% of the rapidly growing revenue base. The North American class III gaming operations installed base, which in our opinion is the most lucrative category and defensive segment, continues to grow strongly. The installed base grew by almost 20% and should grow at a high single digit pace for the next five years. This implies a long-term market share of around 45%, compared with approximately 38% currently.

We maintain our view the company’s market share in Australia has peaked. This showed in the result with unit sales softening slightly during the first half. In our view the approximate 60% market share is unsustainable, given intensely competitive environment, and we envisage this tapering off by a couple hundred basis points over the next few years to the mid-50% range. Despite the soft domestic revenue, the more favourable product sales mix, and increased uptake of the subscription model helped increase domestic EBIT margin by 190 basis points to 47%. We see margins hovering in the mid-40% range for the foreseeable future.