In the five years since March 2020, we estimate the number of Aristocrat’s (ASX: ALL) North American leased electronic gaming machines has increased by 51% to around 74,000 units. Rival Light & Wonder’s units have grown by 13% over the same period, while we estimate IGT’s installed base has declined slightly.

Why it matters: Aristocrat, Light & Wonder, and IGT together dominate the electronic gaming machine industry. We estimate that the three major players together command the vast majority of both North American outright sales and a similar proportion of leased machines.

  • Aristocrat is pulling ahead. Its already strong competitive position has only strengthened since the pandemic. We estimate Aristocrat’s North American installed base is now larger than IGT’s and Light & Wonder’s combined.

The bottom line: We raise our economic moat rating for Aristocrat to wide, from narrow previously. We increase our fair value estimate to $65 per share, from $52 previously, principally due to the moat upgrade, hence the duration for which we expect Aristocrat to generate excess returns.

  • We think Aristocrat is very likely to outearn its cost of capital over the next decade, and excess returns are more likely than not to persist in the following decade. This satisfies the threshold for a wide economic moat.
  • Shares are slightly overvalued after the upgrade. With top-performing game franchises, Aristocrat dominates in gaming machines. But we think the market is too optimistic about the long-term strength of its fast-growing digital businesses, like digital casino, which are more competitively challenged.

Big picture: We expect Aristocrat to dominate in a relatively consolidated market. Success in the electronic gaming machine industry is highly dependent on new game/cabinet design and development, and larger players can generally outspend their smaller peers.

Gaming machines underpin Aristocrat’s Wide Economic Moat

We expect Aristocrat Leisure to continue to dominate the electronic gaming machine market, particularly in North America. 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 wide economic moat.

Aristocrat is among the top three global competitors in the highly competitive EGM market, alongside International Game Technology and Light & Wonder. We estimate Aristocrat’s North American ship share is now about 27%, from around 23% in prepandemic 2019, and around 13% in 2012. We estimate IGT has a similar share of outright sales, with Light & Wonder a few percentage points behind. We estimate Aristocrat commands a number-one position in Class II and Class III leased machines with more than 40% of the installed base, bolstered by the Video Gaming Technologies acquisition in 2014. These leased, rather than purchased, machines represent the majority of American land-based sales and attract a fee-per-day arrangement (which can be fixed or performance-based). In our view, this revenue is more naturally recurring than direct EGM sales.

Bulls say

  • Aristocrat operates in a market protected from new entrants, as stringent regulatory licensing requirements in major markets create barriers to entry for new players.
  • Unlike the mature electronic gaming machine industry, the fast-growing mobile gaming market provides an avenue of strong growth for Aristocrat.
  • Already boasting a portfolio of highly regarded electronic gaming machines, Aristocrat outspends rivals on R&D, allowing it to improve its competitive position and protect its wide economic moat

Bears say

  • In the pursuit of continued earnings growth, Aristocrat is at risk of overpaying for acquisitions in its competitively more challenged digital gaming business.
  • Aristocrat is hostage to the financial health of casinos and venues purchasing its products.
  • With less turnover likely up for grabs in the near term, heavy discounting could weigh on Aristocrat’s profitability in the fiercely competitive electronic gaming machine industry.

Get Morningstar insights in your inbox

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.