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Treasure Chest: US Expansion Pays Off For Aristocrat Leisure

Treasure Chest | Nov 14 2016


Aristocrat Leisure is broadening its portfolio in North America and it is paying off.

By Eva Brocklehurst

Gaming machine manufacturer, Aristocrat Leisure ((ALL)), is tackling market share, broadening its portfolio in North America. Market share gains are also supported by a favourable competitive environment, as three of its major competitors in the US are currently distracted by merger transactions. The acquisition of VGT, a US Class II game supplier, and entry into social gaming, adds to the stock's attractive earnings growth profile.

Citi believes the upcoming FY16 result should be a positive catalyst, expecting a comfortable beat to earnings guidance. This is because of ongoing momentum in North America. The transition to a new CEO is no major surprise to brokers and considered low risk in nature. Trevor Croker is believed to be a strong internal successor, well known and well regarded.

Credit Suisse concurs. Under Jamie Odell's leadership investment was encouraged and methodically allocated to both existing and new markets. The broker believes the signal is clear to investors, growth will continue but decelerate. Aristocrat has made large gains sourced from its maturing market share and medium-term growth is expected to be sourced differently.

The choice for the new leader is to either make further gains from the current array of products and geographies or also undertake significant investment in new segments. The broker upgrades FY17 volume and price expectations as channel checks suggest the company can at least hold its share, if not gain share next year. Credit Suisse also expects the company to significantly expand US participation in its installed base.

The broker assumes Aristocrat reaches an installed base in the US of 15,000 units by FY19. Even though a company may have a market leading product today, it ultimately reaches a point of saturation in terms of venue, the broker notes. Venues then seek and encourage alternative suppliers. While bulls would highlight that it remains early in the cycle, Credit Suisse calculates there are probably two more years of gains in market share.

The broker believes management needs to think about the longer term, in order to establish a new base for the company, and the new CEO will be quizzed for his thoughts about significant acquisitions. In making positive adjustments for FY17 volume and price expectations, the broker notes the Australian dollar has strengthened against the US dollar. Credit Suisse also lowers its digital growth forecast, observing a maturing of that industry.

Credit Suisse assumes volumes in Australia will taper in FY18 and FY19, as demand for replacement machines softens. Gaming turnover growth is also observed to be slowing. Deutsche Bank is more confident, noting that while domestic gaming revenue growth has softened in FY17 to date, it should remain robust and be reasonably supportive of Aristocrat Leisure.

Credit Suisse doubts the stock will exceed its recent price/earnings ratio as FY18 comes into view. The broker considers its estimates of the price/earnings (PE) ratio of 22 times earnings per share for FY18 as a peak for the stock, but acknowledges this could be maintained with a strong balance sheet and solid growth. Credit Suisse has a Neutral rating and $15.65 target.

Macquarie estimates the company will grow its North American ship share to around 27% by 2024, from 20% currently, as it builds on a low share of the stepper market and continues to grow its share of the Class III market. The broker believes the adaptation of two of the company's most popular titles to the stepper platform brings significant growth potential.

Buffalo Grand will be available on the VGT stepper platform from May 2017 and Lightning Link, which was recently voted as top game by customers, will be available on five reel stepper machines from July/August 2017. While competitors have launched linked games, Macquarie believes these lack the brand strength of Lightning Link along with the benefit of an early market entry.

The broker calculates a PE ratio of 20 on FY18 earnings estimates, in line with a long-term average, given ongoing earnings momentum and notable upside potential surrounding North American ship share and digital earnings.

Citi retains a high conviction Buy rating and $18.75 target, envisaging the current share price as attractive, with the stock trading around a price/earnings ratio of 19 based on its FY17 estimates. The free cash flow yield of 6.5% and strong balance sheet underpin the broker's conviction. Citi's estimates for FY16 and FY17 are 7% above guidance and consensus respectively.

FNArena's database shows four Buy ratings and one Hold (Credit Suisse). The consensus target is $17.80, suggesting 25.7% upside to the last share price. Targets range from $15.65 (Credit Suisse) to $19.70 (Deutsche Bank).

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