Not All Gaming Stocks Are Winners

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New gaming sector research compares Light & Wonder with Aristocrat Leisure, as well as the defensive investment opportunity provided by Lottery Corp.

-Inaugural research by Goldman Sachs on three gaming stocks
-Light & Wonder to challenge Aristocrat’s long-term dominance
-Lottery Corp’s infrastructure-like characteristics
-Capital management initiatives for the trio

By Mark Woodruff 

New Australian Gaming research coverage by Goldman Sachs compares heavyweights in land-based gaming, Aristocrat Leisure ((ALL)) and Light & Wonder ((LNW)), along with first-time analysis of market leader in domestic lotteries, Lottery Corp ((TLC)).

Within the ASX200, Aristocrat Leisure, Lottery Corp, and Light & Wonder rank 16th, 45th, and 135th, respectively, with market capitalisations of $33.4bn, $11bn, and $3.6bn.

The broker prefers Light & Wonder (Buy) over Aristocrat Leisure (Neutral) given a greater risk-reward skew, and while Lottery Corp is considered well-placed to deliver through-the-cycle growth, the analysts assign a Neutral rating due to a very strong jackpot cycle into FY24 leading to tough upcoming comparative numbers in FY25.

Providing a defensive investment opportunity with infrastructure-like characteristics, Lottery Corp is the exclusive lotteries and Keno operator with near national coverage across Australia, explains Goldmans.

For the longer-term, the analysts anticipate turnover growth will be supported by population growth, game changes, and price changes.

Margins should also expand over time, suggests the broker, due to the ongoing transition of customers from retail to higher margin digital channels, and a relatively fixed cost base.

Of six covering brokers in the FNArena Database, five have Buy (or equivalent) ratings for Lottery Corp, while Morgan Stanley is Equal-weight-rated on anticipation of flat earnings growth in FY25.

Acknowledging the market view of soft growth in the short term, Ord Minnett notes long-term empirical evidence of a reversion to trend growth of circa 5% per annum, which is likely to occur from FY26.

Ord Minnett prefers Lottery Corp over Jumbo Interactive ((JIN)) in the category.

While downbeat on earnings growth, Morgan Stanley also notes potential for capital management upside.

Certainly, Macquarie will be on the lookout for any changes to dividend policy at the FY24 result for Lottery Corp on August 21.

Current policy dictates an 80-100% payout ratio versus net profit, pre-significant items, but there are suggestions of changing the dividend payout policy to cash earnings, which equals to NPAT excluding the -$35m non-cash amortisation of Lotteries and Keno licences.

Should this policy change occur, Macquarie forecasts an around 1.6cps boost to the dividend (FY23 dividend:14cps) implying a 3.3-4.2% dividend yield in FY25. It’s anticipated this dividend will be fully franked, even at the high end of the payout range.

While strong jackpot sequencing and cost guidance de-risks FY24 results, in Morgan Stanley’s opinion, the FY25 cost outlook remains a key area of uncertainty post the de-merger from Tabcorp holdings ((TAH)) in May 2022.

The $5.62 average target price in the FNArena Database suggests nearly 12.5% share price upside.

Aristocrat Leisure versus Light & Wonder

Aristocrat Leisure and Light & Wonder design, develop and distribute gaming content, platforms, and machines, while also developing, marketing, and operating social games and iGaming (the term for online gaming).

It’s important to note machine sales and gaming operations (i.e. leases via fixed fee or revenue share model) to land-based casinos make up the majority of revenue and earnings for both players.

Because of a skew to premium cabinets, Aristocrat and Light & Wonder command a higher daily-revenue-per-unit (DRPU) of US$55 and US$49, respectively, relative to the third key player in North America, International Game Technology (IGT), which generates US$41 of DRPU, explains Goldman.

For the uninitiated, a premium cabinet refers to a high-end, feature-rich housing for slot machines or other electronic gaming devices, which may involve enhanced display or audio-visual elements (for example).

Both companies have similar strategies and business mix, notes Goldmans, including growing their respective land-based presence, a content-driven approach facilitating the next leg of growth in social gaming, and investing in real money gaming (RMG).

There is also a common focus on reinvestment via design and development.

Such similarities may be no coincidence, given Light & Wonder’s Chairman Jamie Odell’s former title was CEO of Aristocrat Leisure. Under his watch, Aristocrat gained significant market share and became established as a global leader in gaming.

Light & Wonder also employs around 65 former Aristocrat senior and mid-level managers and game designers.

Goldman Sachs prefers Light & Wonder due to greater earnings upside, a more concentrated social casino segment (leveraging land-based gaming), and scope for further market share consolidation in the Gaming division driven by the launch of slot machine game, Dragon Train.

In March, Light & Wonder announced the official North American debut of Dragon Train, which has become the company’s fastest-selling game in the Australian market since its launch in 2023.

Light & Wonder’s stronger track record in iGaming is another point of difference, according to Goldman, an area where Aristocrat (via the Interactive segment) has been a relatively late entrant.

More positively for Aristocrat, Macquarie recently suggested Interactive’s market share (currently 4.5%) will rise due to an increase in content and product availability via leveraging Aristocrat’s deep and broad portfolio.

This broker predicts the Interactive division will grow by simply entering new jurisdictions, as Aristocrat is currently only operating in three of seven US iGaming markets.

At Aristocrat’s recent investor day, management set a FY29 US$1.0bn revenue target for the Interactive business, well ahead of the FY29 consensus estimate for US$681m, highlighted Morgan Stanley.

Despite headwinds in the broader social gaming industry, Goldman believes Light & Wonder’s SciPlay business is out indexing the social casino segment, driven by higher monetisation rates and modest user growth. SciPlay offers various popular games such as Jackpot Party Casino Slots, Hot Shot Casino, and Bingo Showdown.

Back in A&NZ, the success of recently launched games provides Goldman with confidence Light & Wonder can achieve similar growth in the much larger North American market.

Heightened competitive pressure from a more focused Light & Wonder should challenge Aristocrat’s long-term dominance, in the analysts’ view.

In North America, Goldmans suggests Aristocrat is well-positioned for strong growth in FY24 driven by outperformance in gaming operations, but, after this time, growth rates will potentially ease as the company may be close to reaching a natural market share ceiling.

Capital management initiatives

As both companies have strong balance sheets, Goldman Sachs reviews capital management initiatives, largely in the form of on-market buybacks, to return capital to shareholders.

Ongoing improvement in free cash flow (FCF) is a key factor justifying Goldman’s positive stance on Light & Wonder and provides optionality for capital management.

Aristocrat generates revenue across land-based gaming, real money gaming and Pixel United (social casino and casual games), but the latter (apart from social casino) is undergoing a strategic review by management, which the broker explains could provide capital management flexibility.

Citi estimates capacity for around $60m of capital management and proceeds from the potential sale of digital assets could provide further funds in the range of $1.7-2.3bn.

On the flipside, Goldman notes the timing is uncertain and there’s no guarantee of a sale.

The strategic review is in line with the company’s focus on driving synergies between Aristocrat’s social casino portfolio and the land-based segment, explains Goldman.

The average target price for Aristocrat Leisure of six covering brokers updated daily in the FNArena Database is $54.05.

Five of the six brokers have Buy (or equivalent) ratings and Ord Minnett is Hold-rated.

For Light & Wonder, there are two Buys and two Holds, with an average target of $165.

Outside of daily coverage, Canaccord Genuity is Buy-rated, with a $175 target.

The research by Goldman Sachs has target prices for Aristocrat and Light & Wonder of $55.30 and $190, respectively.

Jarden is Buy-rated on Aristocrat and Light & Wonder with respective targets of $47.20 and $166. 

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