Aristocrat switches jockeys

After Jamie Odell’s successful tenure, what now for Aristocrat under new chief Trevor Croker?

Aristocrat’s 2016 AGM was the last with Jamie Odell as chief executive before Trevor Croker took the reins earlier this month. Croker followed Odell from Fosters after Odell moved to Aristocrat in early 2009 so there’s a certain symmetry to this transition.

As managing director of the company’s Australia and New Zealand operations from 2009 to 2015, he engineered a recovery in these markets so that it is now once again the clear market leader. From 2015 to 2016 he led Aristocrat's digital business before taking charge of global products and product development last year.

So on the face of it, Croker seems a good choice but, after Jamie Odell’s successful tenure (see Aristocrat Leisure: Result 2016), does his appointment represent a change or more of the same? 

Key Points

  • Trevor Croker replaced Jamie Odell on 1 March

  • 2017 guidance raised

  • Price guide increased

At the AGM, Croker promised to ‘[focus] on continuity and building on [Aristocrat's] foundations rather than introducing change for change’s sake’. However, he added that the company should ‘evolve’ its focus to ‘fully leveraging [its] momentum, and transforming [the] business over time’, as growth will naturally slow if the company sits still.

Leveraging existing business

The first part of that – leveraging momentum – makes eminent sense. Stripping out the management speak, it means using the company's core strengths to take it into adjacent markets, and there's plenty of scope for this, particularly in North America.

Aristocrat’s Class III business in the region (see Shoptalk) – which includes outright sales of machines to casinos as well as machines leased to casinos in return for a share of the daily winnings – currently focuses on the video segment of the market.

Shoptalk
Class III games include slot machines that you generally find in Australia and around the world in casinos where a random number generator determines whether a player wins. Class II games are generally games of chance known as bingo linked to a central server that determines which player wins.

There are more than 700,000 Class III machines in casinos across North America. Of these, 75% are video machines while the remainder (known as 'steppers') are based on mechanical reels.

In terms of outright sales, around 60,000 Class III machines are sold each year, with 36,000 being video machines and the remainder being steppers. 

So it makes sense to expand into the Class III stepper market. Aristocrat’s initial portfolio of games have been approved and released into a few casinos with ‘encouraging early results’.

The acquisition of Video Game Technologies or VGT (see Odell bets his reputation) has no doubt helped here, given the intellectual property and know how arising from VGT’s strong position in the Class II stepper market.

Similarly, Aristocrat’s expertise in video-based Class III machines will help it in expanding into the Class II video market. Here too it has recently released a few games to good reviews. At around 85,000 machines in total, the Class II market is a lot smaller than the Class III market. However, it still represents a reasonable opportunity for Aristocrat to add video machines to the more than 21,000 stepper machines currently leased by VGT to Native American casinos.

The company will also enter the North American Video Lottery Terminal (VLT) market in 2018. VLTs are multi-game electronic machines that have slot games as part of their offering.

Table 1: Key financials
Year to 30 Sep 2013 2014 2015 2016
Revenue ($m) 814 870 1,582 2,129
U'lying EBITDA ($m) 188 210 523 806
U'lying EBIT ($m) 145 161 431 673
U'lying NPAT ($m) 107 118 236 398
U'lying EPS (c) 19.4 20.7 37.1 62.4
DPS (c) 14.5 16.0 17.0 25.0

We can’t quibble with this strategy, as Aristocrat’s reputation for producing quality cabinets and popular games should help convince customers in adjacent markets to try its products.  

Moreover, this expansion should produce further economies of scale by spreading design and development, marketing, and sales and distribution expenses over a wider range of products and customers.

On the digital front, the company also released a new online social casino app named Cashman Casino in December to complement its highly successful existing Heart of Vegas app.

Further acquisitions possible

We’re more sceptical, though, of Croker’s promise to ‘transform the business over time' to maintain growth. Despite assurances, the risk here is that the company takes its eye off its currently high-performing businesses and stops releasing games that are popular with punters.

Moreover, while we acknowledge that the company’s acquisitions of VGT and digital gaming company Product Madness have been very successful, we’re wary of further ‘transformational’ acquisitions just to maintain rapid growth. Jamie Odell noted that US investors view Aristocrat as a 'growth company', but we hope that doesn't influence management when considering further acquisitions. 

Less cyclical business

In the meantime, though, half of Aristocrat's revenue is now generated from recurring sources. This includes income from Class II and Class III machines leased to casinos in return for a share of daily winnings as well as income from the digital business.

So, with the company relying less on lumpy revenues from the outright sale of machines, its earnings should now be less cyclical.  

Moreover, the company’s copious cash flow in recent years has allowed it to reduce the substantial debt taken on to acquire VGT (see Odell bets his reputation). Net debt now stands at 1.2 times earnings before interest, tax, depreciation and amortisation (or EBITDA), down from 3.6 times following the acquisition.

Table 2: Segment results
Year to 30 Sep 2016 2015
Segment revenue    
Australia & NZ ($m) 413 314
Americas ($m) 1,255 980
International Class III ($m) 181 140
Digital ($m) 280 148
Segment operating profit    
Australia & NZ ($m) 169 113
Americas ($m) 600 451
International Class III ($m) 81 52
Digital ($m) 118 50
Note: segment results are before design and development expense

With the company’s $500m in free cash flow in 2016 likely to increase in 2017 and its payout ratio of only 40%, debt should continue to decline. This will provide capacity to undertake further acquisitions and/or return more cash to shareholders.

Slower growth likely

However, as Croker has noted, without further acquisitions the company’s recent success in Australasia and North America means growth is likely to slow in coming years.

Although not quite yet. Further improvements in the company’s performance in the first four months of 2017 have led management to give guidance for growth of 20–30% in underlying net profit (before amortisation of acquired intangibles) from the $398m earned in 2016.

The midpoint of that range would mean a 2017 underlying net profit of around $498m, or 78 cents per share. That puts the stock on a forward multiple of 23, suggesting that investors expect reasonable levels of growth to continue – and high enough to induce a sharp sell-off should anything go wrong.

Our record with Aristocrat is chequered to say the least. After positive recommendations at various prices from $6.76 in 2008 down to $1.98 in 2011 and back up to $2.81 in 2012, feelings of relief perhaps clouded our judgement and we sold way too early on the way back up – at $6.03 in 2014. So, while management change always involves risk and Aristocrat remains a cyclical business, we’re reluctant to make the same mistake again.

This is a strong business performing well and we're bumping up our Sell price, by $2 to $20, with the Buy price rising by a similar amount, to $12. Note that this still puts it near the top of our Hold range, so it might make sense for some to take some profit – particularly if your holding is close to or above our recommended maximum weighting of 5%. HOLD.