Shares in Australian gaming giant Aristocrat Leisure Limited remain undervalued, with investors caught up on temporary softness in the company’s gaming operations and therefore failing to adequately value its long reinvestment runway, according to financial services firm Morningstar.
Aristocrat is one of a handful of ASX-listed companies highlighted by Morningstar market strategist Lochlan Halloway in a Friday note in which he explored the concept of “reinvestment runway” – an ideal that captures both the durability of the moat and the universe of value-accretive investment opportunities.
While some companies can tap out substantial expansion opportunities, those with a long reinvestment runway can maximize the value of a competitive advantage and reduce the risk that they might fall into the trap of scrambling into value-destructive investments in a futile attempt to reignite growth.
According to Halloway, long reinvestment runways are often mispriced by the market – leaving opportunities for savvy investors able to identify “moated” businesses that still have plenty of room to expand and can do so at high rates of incremental return.
Aristocrat, he notes, currently holds around 27% of new electronic gaming machine shipments in North America – the world’s largest EGM market – up from 23% in 2019 and 13% in 2012.
Those phenomenal share gains, he adds, reflect relentless R&D investment with around 12% of revenue flowing into new games, cabinets and content and representing a much higher rate of spending than peers.
The returns, however, justify the spend with Aristocrat averaged 17% return on invested capital over five years and 24% over the past decade, well above its 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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