Company Reports

The United States District Court of Nevada has granted Aristocrat a preliminary injunction against no-moat Light & Wonder’s Dragon Train game, prohibiting further sales in the US. The case centers around similarities between Light & Wonder’s game and narrow-moat Aristocrat’s highly successful Dragon Link series, including allegations of copyright infringement and misappropriation of trade secrets. Specifically, intellectual property and game mechanics, and the role former Aristocrat employees, now at Light & Wonder, had in its development. The court decision finds Aristocrat is “extremely likely to succeed” in demonstrating trade secrets were misappropriated in the development of Dragon Train.

Aristocrat Leisure is performing better than expected. Underlying fiscal 2024 first-half net profit lifted 16% on the prior corresponding period to AUD 764 million. The core electronic gaming machines business continues to capture share, increased monetization in digital gaming is more than offsetting falling player numbers, and profitability in the nascent iGaming business is improving. We lift our fiscal 2024 underlying net profit forecast by 13% to AUD 1.5 billion, a 17% improvement on the PCP as earnings from the NeoGames acquisition come online during the second half. We lift our fair value estimate by 7% to AUD 48 per share due to the increase in near-term earnings, a larger installed base leading to higher longer-term earnings, and the time value of money.

We expect Aristocrat Leisure will continue to dominate the electronic gaming machine market. With a strong balance sheet and commanding market position, Aristocrat's research and development expenditure is unmatched by peers. This investment is the lifeblood of any electronic gaming manufacturer, especially given rapidly changing technology and consumer demands, and allows Aristocrat to maintain game quality, differentiate products from lower-end competitors, and defend its narrow economic moat.

Narrow-moat Aristocrat’s deep portfolio of highly popular and profitable gaming machine titles, like Dragon Link, has allowed the firm to capture a significant share of the key North American market. We estimate the three major players—Aristocrat, no-moat Light & Wonder, and International Game Technology—together command the vast majority of both North American outright sales and a similar proportion of leased machines. In the four years since December 2019, we estimate the number of Aristocrat’s North American leased machines has increased by 34% to around 65,000 units. This is in stark contrast to Light & Wonder, where unit numbers have been roughly flat over the last four years, and to International Game Technology, where the number of machines has fallen by about 5%. Aristocrat’s leased units in North America are roughly the size of IGT's and Light & Wonder's combined.

We lift our fair value estimate for shares in Aristocrat to AUD 45, from AUD 43 previously, following the release of fiscal 2023 results. The increase to our fair value estimate is principally due to the time value of money. Underlying net profit after tax lifted 21% to AUD 1.3 billion, about 9% above our forecast. But underlying EBIT was only about 3% above our prior forecast as we underappreciated the interest income on Aristocrat's net cash position.

Aristocrat shares are trading at a slight discount to our unchanged AUD 43 fair value estimate, after recovering strongly from lows of near AUD 30 at the beginning of 2023. We think the market is now appropriately balancing the firm's dominance in land-based gaming against slowing tailwinds in Aristocrat's digital businesses. We estimate Aristocrat's highly popular and profitable gaming machine titles, which underpin its narrow economic moat, will allow the firm to continue to capture share in both outright sales and leased machines in the key North American market.

We maintain our AUD 43 fair value estimate for shares in Aristocrat following the release of interim fiscal 2023 earnings. Underlying net profit of AUD 659 million is up 14% on the prior corresponding period, or pcp. Strong performance in the core electronic gaming machine, or EGM, business offset earnings weakness in Pixel United—Aristocrat's online gaming division. The net result was buoyed by sharply lower net interest costs (higher interest rates have benefited Aristocrat's net cash position) and favourable foreign currency translation. We lower fiscal 2023 underlying NPAT forecast by 2% to AUD 1.2 billion, principally due to the softer-than-expected Pixel United result. The board declared a fully franked interim dividend of AUD 30 cents per share, tracking our forecast for total fiscal 2023 dividends of AUD 64 cents per share, fully franked.

We maintain our AUD 43 fair value estimate for shares in Aristocrat following fiscal-year 2022 earnings. Underlying net profit lifted 27% to AUD 1.1 billion—about 5% above our prior forecast. The strength of the land-based gaming business in North America stands out with earnings roaring back following two years of COVID-19 disruptions. At current prices, Aristocrat screens as a good value. We think the market is too focused on slowing tailwinds in Aristocrat's digital businesses, overlooking the firm's dominance in land-based gaming that underpins its narrow economic moat.

Shares in Aristocrat screen as cheap compared with our unchanged AUD 41.00 fair value estimate. We think much of the focus has been on the firm's entry into online real-money gaming in the U.S., and the ill-fated PlayTech acquisition attempt. But we think the market has been distracted by this opportunity, overlooking the strength of the core land-based gaming business which underpins the firm's narrow economic moat.

We maintain our AUD 36.00 fair value estimate for shares in narrow-moat Aristocrat following the release of fiscal 2021 results. Underlying net profit of AUD 865 million--81% higher than the prior corresponding period--was virtually pre-reported. Please see our note published Oct. 19, 2021: "Corporate Action: Aristocrat's Renounceable Rights Give Investors an Each-Way Bet." The result was overshadowed by two potential suitors circling Playtech since the announcement of Aristocrat's bid, including Playtech's second-largest shareholder Gopher Investments (with a stake of about 5%). But no formal competing bids have been made, and the Aristocrat board continues to expect the acquisition to complete during the first half of calendar 2022.

We maintain our fair value estimate of AUD 33 per share following the release of narrow moat rated Aristocrat's interim fiscal 2021 results. First-half underlying NPAT of AUD 412 million was pre-released (see our note published May 18, 2021: "Aristocrat's Dominant Position Reaps Rewards as Gaming Recovers"), representing an increase of 12% on the prior corresponding period, or pcp, tracking our full-year forecast of AUD 809 million. While digital gaming growth grabbed headlines, we are also encouraged by the core land-based electronic gaming machine, or EGM, business capturing share in a down market.

We maintain our AUD 33 fair value estimate for Aristocrat shares and we expect the firm to continue to command a dominant share in major markets. In our view, Aristocrat enjoys a narrow economic moat underpinned by intangible assets in its core electronic gaming machine, or EGM, business. Stringent regulatory licensing requirements in major markets create barriers to entry for new players, and Aristocrat's extensive portfolio of popular games allows the firm to enjoy economic returns in this environment. Success in the EGM industry is highly dependent on new game and cabinet design and development. While the occasional hit game can come down to chance, we expect the ability to consistently deploy popular titles will come down to investment over the long run. This is illustrative of the industry dominated by three major players--Aristocrat Leisure, International Game Technology, and Scientific Games--which control the vast majority of the EGM market in North America. We estimate Aristocrat will maintain research and development investment of around 12% of sales over the long term. This investment is the lifeblood of any EGM manufacturer.

We expect Aristocrat Leisure will continue to dominate the electronic gaming machine, or EGM, market. With a strong balance sheet and commanding market position, Aristocrat's research and development expenditure is unmatched by peers. This investment is the lifeblood of any electronic gaming manufacturer, especially given rapidly changing technology, and allows Aristocrat to maintain game quality, differentiate products from lower-end competitors, and defend its narrow economic moat.

We maintain our AUD 33.00 fair value estimate for shares in narrow-moat Aristocrat following the release of its fiscal 2020 financial result. Fiscal 2020 was a difficult year for Aristocrat, with underlying net profit dropping 47% to AUD 477 million--but ahead of our AUD 451 million forecast. As expected, earnings weakness was principally due to Aristocrat's outright electronic gaming machine, or EGM, sales which have been hard-hit as coronavirus-induced shutdowns, social distancing measures, and travel restrictions weighed on the firm's casino and club customers.

We raise our fair value estimate for Aristocrat Leisure to AUD 33 per share, from AUD 27, following the transition to a new analyst. We expect Aristocrat Leisure will continue to dominate the electronic gaming machine, or EGM, market. With a strong balance sheet and commanding market position, the firm's research and development, or R&D, expenditure is unmatched by peers. This investment is the lifeblood of any electronic gaming manufacturer, especially given rapidly changing technology, and allows Aristocrat to maintain game quality, differentiate products from lower-end competitors, and defend its narrow economic moat.

We lower our fair value estimate for narrow-moat rated Aristocrat Leisure by 2% to AUD 27 per share following the release of first-half fiscal 2020 results. Electronic gaming machine, or EGM, sales have been particularly hard-hit by coronavirus-induced shutdowns of most of the firm's customers. Sales volumes were weaker than our prior expectations, despite shutdowns coming into effect at the tail end of the period. We anticipate Aristocrat's customers may have been slowing capital expenditure prior to shutdowns, and we lower our full-year fiscal 2020 forecasts accordingly. Nevertheless, the digital business continues to perform strongly, and in our view, Aristocrat remains in a good position to bounce back when capital expenditure begins to flow again. Since recovering from March lows, shares in Aristocrat are beginning to screen as fairly valued.

As a result of the current market rout, narrow moat Aristocrat Leisure now trades at a meaningful discount to our unchanged fair value estimate of AUD 27.50 per share, and narrow moat Ainsworth trades at an even deeper discount to our intact fair value estimate of AUD 1.10 per share. We expect the impact of COVID-19 to weigh on the firms' near-term earnings as customers reduce capital expenditure to protect balance sheets amid shutdowns of nonessential public venues--including clubs and casinos. But our fair value estimates are intact as we expect the impact to be short term. Our long-term earnings forecasts are largely unchanged and the time value of money offsets the lower near-term earnings outlook.

We raise our fair value estimate for Aristocrat Leisure by 6% to AUD 27.50 per share following the annual results. This increase is driven by strong North American performance, a lower effective tax rate moving forward, and the effects from the time value of money. Fiscal 2019 normalised net profit after tax and before amortisation of acquired intangibles, or NPATA, of AUD 894 million was in line with our AUD 890 million estimate--a 23% increase on fiscal 2018. The poker machine manufacturer enjoyed another strong year in North America, with growth in market share and yield. Aristocrat’s competitive advantages in the key North American market underpin the firm's narrow economic moat. We expect continued market share gains in North America to drive a low double-digit NPATA CAGR over the five years to fiscal 2024.

We transfer coverage of Aristocrat Leisure and maintain our AUD 26.00 per share fair value estimate. We reiterate our narrow moat, high fair value uncertainty, and Standard stewardship ratings and continue to forecast 14% EPS growth on average for the next five years. Our forecasts hinge on further market share gains in North American outright sales. We believe the firm can reach 30% by fiscal 2023, compared with roughly 25% currently. Additionally, the North American class III gaming operations installed base (leased machines) should continue to grow strongly. In our opinion, this is the most lucrative category and defensive segment and we forecast Aristocrat to capture a long-term market share of around 45%, compared with the current 38%. The firm’s ongoing commitment to game design and development expenditure is a key driver.

As we have long expected, Senate Republican leadership recently passed a “tax reform lite” plan that has the potential to bring about lasting changes to the U.S. corporate tax system. While we may modify certain tax reform-related assumptions incorporated into our models, we don’t anticipate a material change in our fair value estimates or economic moat ratings for firms with U.S. earnings exposure, due to various offsetting factors. We believe tax reform is more likely than not to occur and the product of the House and Senate’s reconciliation efforts in committee will directionally align with our previous assumptions. As a reminder, we had assumed the following in our models: 1) a 25% corporate tax rate beginning in 2018; 2) an election for firms to either fully expense their U.S. manufacturing capital expenditures when made or deduct net interest expense; 3) a deemed repatriation tax of 10% on overseas earnings held in cash; and 4) the elimination of certain special interest tax provisions.