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Aristocrat Leisure Remains On Winning Streak

Australia | Nov 21 2019


Aristocrat Leisure has built a strong track record and brokers found little to dislike about the company's FY19 results. The focus is now on a promising digital strategy.

-Narrows its digital target to more profitable user growth
-Australian margin expansion underpinned by favourable commercial mix
-Significant scope for accretive acquisitions/capital management


By Eva Brocklehurst

Aristocrat Leisure ((ALL)) continues its winning streak, with results in FY19 ahead of most expectations. The main engines of growth are North America and the digital business.

Brokers found little they didn't like in the results, although Macquarie notes social casino growth was disappointing. That said, the trend is improving and healthier revenue is considered likely in FY20, albeit skewed to the second half.

The company has built a strong track record and the US remains the spearhead of growth, Citi asserts. As growth in this market begins to mature, the broker notes drivers pivot to adjacent land-based opportunities and online video game RAID. Adjacencies could contribute US$59m in incremental earnings from FY19-21, Citi estimates, which is equivalent to almost half of the Americas segment earnings growth.

UBS found it hard to fault the results. The Australian margin expansion of 120 basis points was underpinned by a favourable commercial mix towards recurring revenue/bundle offers. Churn is currently slower and this situation is expected to continue in FY20.  Meanwhile, the EMEA (Europe, Middle East, Africa) installed base grew 23% and offset some of the declines in other regions.

Credit Suisse is more muted in its appraisal, making only modest upgrades to FY20 estimates. Net profit in FY19 of $894.4m was up 22.6%. The company has 12 new games on the development board, including four in test mode. Ord Minnett is confident of another 12 months of land-based dominance by Aristocrat Leisure, where the company's performance as well understood and predictable.

The focus turns now to the promising digital strategy. Aristocrat Leisure has curtailed investment in lower-quality players in order to grow profitability later on. Because of the ever-changing costs, Ord Minnett suspects Aristocrat Leisure will not provide guidance on margins or expenditure in this business. This is not poor management but rather the unpredictable nature of the bid/ask mobile advertising market, the broker adds.

The RAID game delivered around US$110m in revenue in FY19 and Credit Suisse expects it to grow to US$350m by FY24. Citi has a similar expectation for RAID and continued investment is anticipated for the next 6-12 months, while UBS suspects Aristocrat Leisure is looking at the long-term value of this title, not short-term profit.

Capital Management

The company expects to continue with its current dividend policy in conjunction with managing debt repayments, retaining the potential for bolt-on acquisitions. Redeploying the balance sheet could provide another leg of growth, Citi suggests, through capital management and/or acquisitions.

The broker continues to forecast a $600m share buyback from FY21 in the absence of acquisitions and calculates Aristocrat Leisure could internally funded a $2.5bn acquisition. Morgans agrees there is significant scope for accretive acquisitions and these are likely to be in the digital space where the company is growing its skills and product.

Macquarie observes the company is generating in excess of $1bn in operating cash flow that is supporting rapid deleveraging. Despite rapid deleveraging, Aristocrat Leisure is yet to formalise its optimal capital structure.

The broker believes this stems from a view that growth by acquisition is more attractive than capital management and assesses there is more than $1.5bn available for capital management/acquisitions. Macquarie also believes these qualities are not appropriately reflected in the share price and, while only qualitative guidance was provided, forecasts $1.04bn in net profit in FY20.

Wilsons considers the stock a structurally sound investment and does not believe the growth outlook is fully priced into the equity. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, has an Overweight rating and $36.96 target.

Credit Suisse simply believes the stock has hit a "valuation wall". At 19x FY21 estimates, the PE (price/earnings) ratio is not a stretch and, given the company's excellent fundamentals, the broker suspects investors may move to more comparative valuations and abandon DCF valuations.

The database has six Buy ratings and one Hold (Credit Suisse). The consensus target is $37.29, suggesting 9.9% upside to the last share price. This compares with $34.44 ahead of the results. Targets range from $35.00 (Credit Suisse, Morgan Stanley) to $39.60 (UBS).

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