article 3 months old

Aristocrat Signals Strong Growth

Australia | Dec 01 2016


Gaming machine manufacturer Aristocrat Leisure is guiding to strong earnings growth, as the performance of its key titles enable gains in market share.

-Investing heavily in Class III segment and still under-penetrated relative to competition
-Growth prospects diminish in digital but company can afford to invest in growing user base
-May need to diversify beyond slot machines to crack large markets in Asia


By Eva Brocklehurst

Gaming machine manufacturer Aristocrat Leisure ((ALL)) met lofty expectations to record strong net profit in FY16. The company has guided to continued growth, driven by expansion in the Americas and in the International Class III segment from new openings in the Asia-Pacific region.

Deutsche Bank likes the company's growth in recurring revenue and the strength of net operating cash flow, noting a cash conversion rate of 103% in the results. The broker also finds the company's outlook is more positive than usual and continued growth in market share and profitability is expected in 2017.

Aristocrat reported underlying net profit of $398m in FY16, up 69% and ahead of market estimates. Profit in the Americas was up 33% and Australasian profit was up 49%. Digital profit was up 135%. Despite the strength in the digital division, the company expects profit growth to moderate over 2017 as periods of high successive growth rates are cycled.

The main driver of market share gains in the Class III segment is the performance of the company's titles, UBS observes. While the broker acknowledges that all formats can be cyclical, Aristocrat's current business is taking share and momentum should continue for at least 12 months. The company is investing heavily in this area and still appears to be under-penetrated relative to the competition.

The business model has changed significantly, UBS notes, with recurring revenue likely to contribute more than 55% of group revenue in FY17. The price/earnings ratio being applied to the stock has remained relatively stable, at around 20x over the past three years, despite growth in earnings per share of 48% over that period. With this in mind, UBS believes the market might be underestimating the likelihood that there will be more than one year of strong earnings.

Macquarie believes the company's superior debt and liquidity metrics mean it is well-placed to grow and outmanoeuvre competition. The broker expects ongoing international expansion while dominance in the domestic market will be underpinned by a strong balance sheet.

The broker notes, aside from the growing digital market, the company made reference to flat markets in each of its operating areas. This reflects, in Macquarie's view, clear gains in market share by Aristocrat although it puts the onus on the company to continue developing highly popular titles to continue seizing share.

Credit Suisse expects Aristocrat can achieve around 20% in growth in earnings per share in FY17 as it harnesses the momentum in US recurring revenue, digital business and the International Class III. The broker upgrades forecast for earnings per share by around 11% but valuation is raised by a lesser amount because of rising bond rates affecting the company's cost of capital.

There are signs that growth prospects in the digital division are diminishing and by the company's own admission the social casino sector has begun to mature. Credit Suisse observes virtually no growth in daily active users among the company's publicly listed peers over the past six months.

While the daily users in the digital business were flat sequentially, the broker suspects the company has such a high margin and yield it can afford to invest to grow its user base. Nevertheless, Credit Suisse flattens its long-dated forecasts as the industry is not generating significant growth in users. Officially, the company's guidance is for maintaining average revenue per daily active user as it targets growth in its user base.

The broker suggests there might be an opportunity to target larger pools of users by launching new applications across several geographies and casino categories such as poker, bingo and card games. Aristocrat has recognised the need to diversify into multiple applications and enter new geographies but, Credit Suisse acknowledges, developing other forms of casino games is beyond the company's core competency in its development of high-performing slot content.

The broker suspects the company needs to diversify beyond slots to crack the large markets in Asia where local card games prevail. Credit Suisse's key reason to own the stock is the growth oriented strategy, balance sheet and merger & acquisition potential. The company has stated it is not averse to operating third-party content.

FNArena's database shows four Buy ratings and one Hold (Credit Suisse). The consensus target is $18.40, suggesting 22.7% upside to the last share price. This compares with $17.80 ahead of the results. Targets range from $16.50 (Credit Suisse) to $19.05 (Citi).

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