Aristocrat Pulls Earnings Upgrade Lever

This story features ARISTOCRAT LEISURE LIMITED. For more info SHARE ANALYSIS: ALL

-Capital returns more likely?
-Earnings base shifts higher
-Highlights digital business potential
 

By Eva Brocklehurst

Aristocrat Leisure ((ALL)) has stunned many brokers, delivering a trading update that was well above most expectations. Can the gaming machine business continue to beat forecasts?

The company credited its upgrade to market share gains in North America's Class III segment and Australian outright sales, with improving margins, as well as gains in digital gaming. Profit is expected to be up 66% in the first half.

Deutsche Bank notes the second half is expected to be broadly similar but warns Australia will cycle a strong comparable. The broker increases earnings estimates by 13-15% to reflect higher North American gaming and outright sales earnings as well as higher digital earnings. The broker's dividend pay-out ratio estimate is also raised to 70% from 50%.

In the US, Deutsche Bank now expects earnings growth of 37%, in US dollar terms, and Australian earnings to rise by 42%. The broker believes the company will, in the event of not being able to find suitable investments, look to return further capital to shareholders.

The company appears to be taking share in a growing online gaming market, with Macquarie expecting growth of 33% over the next two years in order to reach $5bn in global revenue. The broker does not believe the company's current 70% share of the Australian market is sustainable in the long term, but envisages it will take time for competitors to erode its advantage.

The broker increases its market ship-share forecasts in North America to 29% for replacement video sales and 25% in new machines. Despite the stock currently trading in line with its long-run average PE multiple, Macquarie does not believe it is expensive on an absolute or relative basis, and maintains an Outperform rating.

UBS upgrades forecasts by 22% and 27% for FY16 and FY17 respectively. The broker assumes a Class III US premium installed base of 13,800-15,800 machines in FY16/17, with VGT's (Video Gaming Technologies) installed base rising to 21,100 machines in FY16.

The broker expects both the Class III installed base and the digital business could provide the next leg of growth. Participation is a higher multiple business, the broker asserts, when compared with outright sales. Recurring revenues are stickier and more valuable in this regard.

Reflecting on the potential upside from participation, UBS estimates Aristocrat has around 17% share of the Class III premium gaming operations in the US. The broker increases its price target by 32% and upgrades to Buy from Neutral.

Credit Suisse also upgrades to Outperform from Neutral, with the company's FY16 forecasts being 20% higher than it previously estimated. Although the broker expects earnings growth to slow to single digits, the base is so much higher now that the target is lifted to $13.00 from $10.50.

 The main engines of growth are the digital and social casino operations as well as US Class III revenue share and, to a lesser extent, the VGT business, the broker suggests.

Credit Suisse is particularly keen on the digital business and believes, in this non-regulated, non-gambling entertainment segment, Aristocrat has a market-leading product that is now just tapping into Asia. The broker suspects the stock may re-rate moderately after consensus forecasts are adjusted for the update and observes there are no international valuation peers, as competitors are heavily geared, part of conglomerates and/or not listed.

Citi, too, found its forecasts were blown away by the update, lifting estimates by 21-26% for FY16-18. The broker does note the company's dividends now look low compared with the strong growth being experienced. Citi has included a graduated lift in the pay-out ratio to 70% by FY18 in its forecasts.

Now, there are six Buy ratings on FNArena's database for Aristocrat Leisure. No Hold, no Sell. The consensus target has risen to $13.17, suggesting 6.7% upside to the last share price, and compares with $10.75 ahead of the update. Targets range from $12.25 (Ord Minnett) to $14.20 (Deutsche Bank).
 

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