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Treasure Chest: Game On For Aristocrat Leisure

Treasure Chest | Jan 20 2022


FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Today's idea is Aristocrat Leisure.

By Sarah Mills

Whose Idea Is It?

Analysts from Jarden

The subject:

Several catalysts are expected to move the dial for Aristocrat Leisure ((ALL)) in the June half as trading rebounds.

More info:

Some of us are old enough to remember Aristocrat Leisure’s birth as a purveyor of poker machines and have watched it transform from a highly successful breeder of one-armed bandits into the world’s number one player in the land-based gaming oligopoly, which boasts high barriers to entry.

It’s a new world now, and Aristocrat Leisure has new-world problems. It may be big on land but it is small fry in the global digital gaming market.

The company now stands at a crossroads, but its transition track record is strong. 

This week’s Treasure Chest idea comes from Jarden, which after conducting a deep dive, has initiated coverage on the company with an Overweight rating and $46.85 target price, spying several catalysts in the June half.

The broker’s target price implies a total shareholder return of roughly 9%. The broker expects a 7% EPS compound average growth rate between FY23 and FY26.

Catalysts rolling through

On the upside, factors Jarden considers likely to drive Aristocrat Leisure’s share price in 2022 include:

-A recovery in land-based gaming post-covid as lockdowns end and chip-supply returns to normal.

-Continued growth in digital: Pixel United’s bookings remained robust in the December quarter and Raid bookings appeared to be outpacing the FY21 run rate in the December quarter.

-The likelihood that Aristocrat will gain extra leverage from market-share gains in its North America gaming operations.

-Acquisition of Playtech at the present bid price, although Jarden spies more risk in making the acquisition than in losing the bid.

-Strong forecast growth in mobile gaming, which received a leg-up from lockdowns and chip shortages, when covid delayed land-games releases.

On the downside, risks are rising and include:

-The Playtech acquisition: Aristocrat recently bid GBP680m for Playtech. But Playtech has been stalling for time as rivals sniff out the opportunity. Jarden expects a potential bidding war may explain recent share-price weakness given a higher bid would equal a reduction in earnings.

-On top of the bidding war risk, Jarden spies Playtech integration risk.

-Earnings risk from high design and development costs: Aristocrat has already guided to higher digital design and development and user-acquisition costs and Jarden queries whether this is structural.  

-Competition for content and talent arising from vertical industry integration from software into gaming and gaming into mobiles (Jarden reports Apple was giving one-off bonuses of up to US$180,000 on top of salaries, stock grants and cash bonuses to retain staff).

-Compression of multiples (bond yields are rising)

-ESG risks

-While competition has eased in land-based gaming, Jarden believes the threat of substitute products and services from categories such as iGamining, iCasino and Sports wagering, while not yet problematic, is growing.

-Regulation of data laws for user acquisition.

A tale of two gaming worlds: land-based and digital

While Aristocrat Leisure seems to have the land-based market under control for now, digital is another matter.

Aristocrat is a relatively small player in a rapidly evolving industry, representing both challenges and opportunity for the digital minnow. 

Evolution is being driven by rapid technological change and economic trends:

-High-end smartphones are cheaper, increasing mobile gamer numbers and the medium-term outlook is strong

-5G and unlimited data plans are also expected to stoke cloud gaming and mobile gaming

-Mobile gaming is a cost-effective opportunity for investors, mobile developers and publishers.

-Evolution into augmented reality and virtual reality.

Jarden notes growth in Pixel will be essential not only to Aristocrat’s digital ambitions but to Aristocrat’s multiple.

Jarden finds the Pixel multiple is already stretched, emphasising the pressure on Aristocrat to grow both Pixel market-share gains and earnings, and Aristocrat’s broader digital offering.

The broker expects vertical industry integration will be needed to combat rising costs (and as we noted above, vertical integration comes with its own costs).

Jarden's fresh optimism is, overall, shared among other brokers covering the stock. Of the six regular brokers daily monitored by FNArena, five rate the stock Buy or an equivalent of Buy, with Morgan Stanley the outsider with an Equal-weight rating and a price target below the share price ($41).

Credit Suisse expects digital will add 5% to revenue in FY22, thanks to recent investment in seven studios and digital staff.

Elsewhere in the FNArena universe, UBS notes the company’s premium portfolio is materially outperforming other manufacturers and holds a target price of $53.60, topping the FNArena rating chart.

Macquarie believes Playtech will be transformational for Aristocrat and reports that most games are performing strongly in both digital and land-based markets. 

Morgan Stanley's commentary is equally positive, but the lower price target suggests it is a matter of how much do we pay to get on board?

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