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Aristocrat’s share price soars 35% higher in 2019

The Aristocrat Leisure Limited (ASX: ALL) share price is up more than 35% in 2019, following an impressive half-year report. Successful innovation and favourable business conditions could make the current Aristocrat share price a long-term buying opportunity.

So what’s behind Aristocrat’s impressive performance

A couple of weeks ago Aristocrat released strong first-half result, which saw its share price surge more than 7%. The gaming technology company beat market expectations by reporting a normalised net profit of $422.3 million in comparison to the $413 million forecasted by analysts.

In addition, the company reported a first-half EBITDA of $766.3 million, which beat market consensus by 5% and improved 19% from the previous year. Revenue also jumped nearly 30% from the previous half to $2.1 billion. With strong growth in free cash flow, Aristocrat also lifted its interim dividend 16% to 22 cents per share.

The impressive results were driven by a strong performance of Aristocrat’s United States (US) division, which reported a 17% increase in revenue to $543.3 million. Of particular note were the results from Aristocrat’s maligned digital gaming sector, which saw revenue for the first half increase 37% to US$586.6 million and earnings also improve 17% to $175.8 million.

Aristocrat’s business transformation

Originally an Australian poker machine producer with small exposure to the US, Aristocrat has transformed over the past 7 years into a leading global player in land-based and digital-based gaming.

Last year, Aristocrat expanded its push into digital and social gaming through the acquisition of US-based Big Fish Games for $1.3 billion and Israeli gaming company Plarium for $635 million. Aristocrat’s share price suffered following the key acquisitions as investors expected that expansion and investment in digital and social gaming would not meet forecasted returns.

The impressive performance of Aristocrat’s digital gaming division was evident in the half-year report and a major reason as to why the share price surged. Aristocrat expects even stronger performance from its digital arm in the second half, following the launch of its role-playing game (RPG) Raid and unveiling of Toy Story Drop, which will coincide with the release of the Toy Story 4 movie in June.

Aristocrat also envisions growth and innovation of its land-based businesses, especially in the US. Currently, Aristocrat is experimenting with video lottery terminals that allow punters to bet on the outcome of video games. In addition, Aristocrat looks to innovate pubs and tavern gaming by having ‘bar-top’ poker machines and interactive games such as bingo.

What are the benefits of Aristocrat’s restructured tax position

After restructuring its tax position outside of Australia, Aristocrat could benefit from a 2.5% earnings boost by taking advantage of lower business tax rates in the US. Currently, approximately 60% of Aristocrats revenue comes from the US where the effective tax rate of 27.5% was reflected in the company’s half-year report.

The effective tax rate is set to drop between 100 and 150 basis points in the 2019 financial year and between 150 and 250 basis points in the 2020 financial year. As a result, analysts expect that the tax changes could result in a 2.5% increase in earnings-per-share (EPS) from the 2020 financial year.

Is it a buy?

Recently, equity analysts at Morgans retained an add rating on Aristocrat and lifted the share price target to $31.95. Although a broker upgrade does not predict the future of the company’s share price, it does indicate where institutional sentiment lies over the short-to-medium term. Analysts at Morgans cited the beat in earnings from Aristocrat as a positive and also alluded to a weaker Australian dollar favouring future earnings and forecasts.

In my opinion, the Aristocrat share price is a buy given its exceptionally strong history of growth. I think that previous valuation of the company based on land-gaming is outdated and does not reflect the growth potential of Aristocrat’s digital business. However, I think it is important to keep an eye on Aristocrat’s marketing spending to acquire new game users. For the first half, marketing expenditure was up 46% to $153 million, so it’s important that this figure doesn’t get out of hand and reflects the best return for marketing dollars.

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Motley Fool contributor Nikhil Gangaram has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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