In early August, we researched Aristocrat Leisure (ASX:ALL) in The Dynamic Investor. We recommended the stock as a buy. Our view was that the stock presented an opportunity on weakness – in particular in light of the recently-outlined growth opportunities for the Interactive division. With the shares having since recovered, we assess whether current levels still present a re-entry opportunity.

About Aristocrat Leisure

Aristocrat Leisure is a slot machine manufacturer. The Company has operations in Australia & NZ (ANZ), the Americas, along with a digital gaming business. Following a newly-created ‘Interactive’ segment, there are currently three reporting segments: Gaming (comprising around 2/3rd of group profit), Pixel United (31%) and Aristocrat Interactive (‘Interactive’).

Key Fundamental Drivers

Multiple (and Significant) Growth Opportunities in Interactive Division

At an Investor Day held in late June 2024, ALL announced its target of achieving at least US$1b in revenue by FY29 for its newly acquired Interactive division. Interactive is split into three segments: i) iLotteries; ii) Platforms and iii) Content. The respective segments within the Interactive portfolio are entering attractive, underpenetrated markets expected to experience double-digit growth in Total Addressable Market (TAM) over the next five years.

The FY29 revenue target set by ALL is a significant leap from consensus estimates of ~US$0.7b for the same period prior to the Investor Day. This implies a compound annual growth rate of approximately 20% over the next five years. Management outlined that in order to achieve this target, the division will need to grow its existing markets as well as entering into new markets. For example, the US market has potential for significant per capita Gross Gaming Revenue (GGR) growth, given that Aristocrat’s content is only available in three of seven US states that have legalised iGaming. Furthermore, the target is not reliant on a specific number of new states legalising iGaming over the next five years.

The majority of this growth is expected to come from the iLottery segment, which currently makes up 18% of Interactive, and Content, which accounts for 22%. Over the past three years, the US market has seen iLottery GGR grow by roughly 30% annually, driven by the opening of new markets and increased spending. Despite this impressive growth, it is estimated that iLottery GGR per capita in US states where it is legal could still quadruple to match Australia’s current online-to-retail penetration ratio.

The Content segment is expected be the fastest Interactive segment, based on scale, synergy and market opportunity. With a current TAM of US$21b, forecast annual growth is 15% annual growth. A key aspect of this growth is that casinos are willing to try Aristocrat’s new titles because they can be easily replaced with one of Aristocrat’s many successful titles should they not perform. Another aspect is that continued strong investment by Aristocrat ensures that it maintains the best portfolio of content.

Potential Upside from Strategic Review into Digital Assets

Pixel United has significantly increased it profit in recent years. Merger & Acquisitions, successful products within Social Casino, RAID: Shadow Legends, and outperformance relative to industry growth have been the key drivers.
Recently, growth in bookings (i.e. revenue) has been challenging. In addition, bookings growth in the near-term is expected to be flat. As a result, the Company announced a strategic review of the casual and mid-core Pixel United businesses. These includes Big Fish (excluding Social Casinos) and Plarium. In context, these products which make up ~40% of total Pixel United bookings.

The driver of the review is a refocus on core capabilities. In particular, while these businesses comprise ~40% of total bookings, they contribute less on a profit basis. This is due to the lower-margin nature of the social casual genre.

Margin Expansion in Pixel United

Despite an overall challenged bookings environment, there is potential for further margin expansion. This is because lower User Acquisition spend is likely to be maintained. In addition, margin benefits are expected from direct-to-consumer platform penetration through Social Casinos. This is expected to mitigate the impact of a recent decline in Aristocrat’s Social Casino bookings. The latter declined in June 2024 and were also lower on a quarterly basis. Despite the monthly decline, Aristocrat outperformed the genre (down ~11% for June).

Balance Sheet Capacity for Capital Management

As at 31 March 2024, the balance sheet was in a net cash position of $366m. This compares to the Company’s medium-term gearing guidance of 1.0-2.0x. As such, this provides scope for further investment in growth or more potential for capital returns via ongoing share buybacks out to FY25.

Should the outcome of the strategic review be to sell Big Fish and Plarium, it is estimated that a possible sale could generate at least US$1.5b, which may be used for additional acquisitions, especially to scale up the Interactive division.

Following completion of the NeoGames acquisition in April 2024, gearing is expected to rise to ~0.6x. Given typically strong cash generation, gearing should progressively step down. This is because share buybacks are expected to be funded out of cashflow.

Fundamental View

ALL shares are currently trading on a 1-year forward P/E multiple of ~21.5x, which is still not overly demanding in the context of an EPS growth profile of ~9% over FY24-26 on a CAGR basis. The key factors supporting the strong medium term EPS growth profile include: i) Growth across all three business segments; ii) Operating leverage, in particular from cost optimisation. Design & Development spend is also expected to taper in the next few years and iii) Further capital management via additional share buybacks.

We contend that there is scope for a further re-rating in the shares as ALL makes progress towards the FY29 revenue target for the Interactive division. In turn, this provides scope for progressive earnings upgrades given that the earnings growth profile for the Interactive division is significantly ahead of the core Gaming & Digital divisions.

Charting View

Several weeks ago, Aristocrat managed to break to a new high. The quick drop in early August then saw it touch the 2021 high near $50 and bounce off it. This means that the $50 zone is an area of support. The past few weeks has seen it consolidate sideways and there has been good buying of the dip. This is a positive sign and it suggests that ALL is nearly ready to head higher again and continue on with its uptrend.

 

Michael Gable is managing director of Fairmont Equities.

 

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