According to analysts at Morningstar, shares of Australia’s Aristocrat Leisure Limited remain undervalued. Investors are too focused on temporary weakness in the land-based gaming equipment segment and are failing to account for the company’s long-term reinvestment potential.
Aristocrat was among the few ASX-listed companies highlighted by Morningstar market strategist Lochlan Halloway in his Friday research note, in which he examined the concept of a “reinvestment runway” – an idea that reflects the durability of competitive advantages and the breadth of opportunities for value-accretive investment. While some companies eventually exhaust their expansion opportunities, those with a long reinvestment runway can maximize their competitive edge and avoid the risk of being forced into inefficient, value-destructive investments in an attempt to revive growth.
According to Halloway, the market often misprices such opportunities – creating an opening for investors capable of identifying “moated” companies with long-term growth potential and high rates of return on invested capital. Aristocrat currently maintains around 27% of new electronic gaming machine shipments in North America – the largest EGM market in the world. For comparison, it held 23% in 2019 and just 13% in 2012. This increase in market share, the analyst notes, has been made possible by continuous investment in R&D: around 12% of revenue is allocated to developing new games, cabinets, and content – significantly higher than the spending levels of competitors.
These expenditures, however, are justified: Aristocrat’s average return on invested capital was 17% over the past five years and 24% over the past decade – well above the company’s cost of capital.
“Two-thirds of earnings are retained and the reinvestment flywheel should continue to drive market share gains in land-based gaming,” Halloway wrote.
“Online casino is a big potential growth avenue, though it’s too soon to say whether the economics will match land-based gaming. Nonetheless, Aristocrat’s library of proven game concepts, refined over decades on casino floors, should provide an edge over pure-play online operators.
“Today, the market seems caught up on temporary softness in Aristocrat’s gaming operations, undervaluing its long reinvestment runway in land gaming, and the growth option in online casino.”
Morningstar is a pioneer of the “economic moat rating”, which it applies as a way of evaluating how durable and defensible a company’s competitive advantages are. The rating insinuating that – much like a medieval castle – a wide moat makes it harder for competitors to attack or erode its profits.
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