Aristocrat Leisure Plays North American Hand
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Aristocrat Leisure ((ALL)) has transformed its North American business since the acquisition of VGT in October 2014, also gaining ground organically via increased participation. Class II and Class III participation businesses are now contributing more than 60% of North American revenue.
Macquarie observes the business has been transformed and participation has improved earnings visibility, although the stock has not re-rated. In recent years the company has reduced its reliance on the outright sales market, which is volatile, by growing higher-quality recurring earnings.
This has significantly improved the cash flow, with the broker noting cash conversion is averaging 100% versus 82% back in FY06-13. Credit Suisse models 23% revenue growth in the second half and suspects this may be bettered given the latest social casino data.
The company's debt position is not onerous, Macquarie believes, even when including the Plarium acquisition and subsequent earn-up payments. Assuming there are no new acquisitions, the broker estimates the company could be debt free by FY21, even taking into account a higher dividend policy.
The broker forecasts 17% per annum average net profit growth in FY17-20. This is largely underpinned by the Class III video participation segment and digital, including Plarium.
Brokers suggest the company still has strong momentum and market share potential within North America. This is coming from three product segments: Class III video participation, and new opportunities in Class II as well as Class III stepper. Class II stepper machines are generally located within Oklahoma, a core market for the VGT business. Stepper machines are mostly mechanical, which is driven by customer preference.
The company remains a small operator in the social casino and social gaming segments with 7% and 1% market share respectively. Brokers expect above-market growth in both businesses in the near-term will be supported by content.
Aristocrat has 24% of the Class III video participation market and, while its share is below competitors such as Scientific Games and IGT, feedback suggests there is momentum with the pending release of the highly-anticipated Dragon Link.
Using the Queensland market as a precedent, Macquarie suspects Dragon Link could drive material numbers of installations and minimal cannibalisation to the Lightning Link base. Lightning Link is the top performing video participation gaming product in North America.
Complemented by the company's 35 other participation titles the broker is forecasting 7000 net installations or 47% growth to FY20, lifting market share to 33% including stepper.
Credit Suisse agrees Dragon Link is a key driver of value for the stock in the near-term. The broker's target price of $22.60 is based upon reaching 20,300 installations by the end of FY18 from an estimated 16,700 as of September this year.
Deutsche Bank also expects North American growth will continue with the release of Dragon Link and the entry into Class III stepper, VLT (video lottery terminal) and Washington markets in 2018. Class II video has also been stronger than the broker expected. Aristocrat entered this market with the Ovation platform in the March quarter.
While Deutsche Bank has some concerns about the breadth of the core content, the game library is considered sufficient to support the existing installed base.
The company's relationship with corporates continues to improve, having recently signed an additional commitment agreement with Caesars encompassing both for-sale and participation products. Deutsche Bank does not expect the emergence of Caesars from bankruptcy will have a noticeable impact on the market, as the company has been purchasing product over the past 12 months.
Meanwhile, the downside risks lie within Australasia and the International Class III businesses in the near-term. Aristocrat currently has the top performing new games in Australasia but at some point another manufacturer will release a new game which will affect ship share. Timing of a material change in ship share is unclear and challenging to forecast, but Macquarie suspects the current ship share of 66% is be unsustainable.
The company has benefited from higher market demand in Asia, as it has generally accounted for around 60% of Macau ship share and 40% elsewhere. Demand may slow across Asia over the next three years, Macquarie contends, although there is the potential for new areas of demand in Macau and Vietnam that cannot be forecast. Macquarie forecasts a 33% decline in segment profit for International Class III in FY18.
FNArena's database shows five Buy ratings and one Hold (Credit Suisse). The consensus target is $24.44, suggesting 9.4% upside to the last share price. Targets range from $23.20 (UBS) to $27.50 (Deutsche Bank).
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