Aristocrat: Interim result 2019

Aristocrat's online operations get all the headlines but it's the old-world gaming business that's pulling the weight - driving a strong result for the six months to March, with revenue up 30% to $2.1bn and underlying net profit up 17% to $422m, or up 8% after adjusting for currency fluctuations. 

Most of the growth was from the Americas division thanks to an 18% increase in the installed base of Class III units, which are the slot machines that you typically find in casinos.

Class II units - machines linked to a central server that determines which player wins - continued to show sluggish sales growth, but managed a 7% increase in the installed base. Unfortunately, average selling prices fell 1%, though management noted a market-leading 1.3% increase in average fees per day to US$50.05.

Aristocrat's Digital division was the main disappointment, despite revenue increasing 37% due to the recent Plarium and Big Fish acquisitions. After stripping these out, revenue was up a modest 2%, while profits fell 7% due to higher marketing costs and a 46% increase in user acquisition costs. Management put the added promotional activity down to new game releases, but it's a reminder that the online sphere is far more competitive than casinos and it's harder to grab a player's attention.

Free cash flow

More than two-thirds of Aristocrat's revenue is now 'recurring' in nature, which is derived from digital subscriptions and those Class II and Class III machines that are rented, rather than sold outright. What's more, the Digital division's expansion means Aristocrat doesn't need to hold as much inventory, which has helped reduce the company's working capital needs.  

This being the case, the business is producing more cash than ever - free cash flow has grown almost 10-fold over the past five years and more than doubled in the six months to March to $288m. The Digital business may not be meeting growth expectations, but this is a silver lining.

Net debt was steady at $2.9bn, though debt grew slower than earnings, so the company's financial position still improved slightly: the interest coverage ratio increased from 11.4 to 11.7. Nonetheless, Aristocrat's volatile sales and fixed costs mean we'd be more comfortable with less leverage or no debt at all.

Management said it expects continued growth for the remainder of the financial year and that the company will maintain a market-leading share of new unit shipments. It also signalled an increase in design and development spending in the Digital division, as well as general corporate costs. 

The stock trades on a price-earnings ratio of 21 based on consensus estimates for 2019 earnings. While the strong Class III sales growth and improving free cash flow is encouraging, Aristocrat's balance sheet and recent acquisitions mean the stock has above-average risks. We're increasing our price guide and sticking with HOLD.