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Takeaway: IGT could be a 20%+ EPS CAGR the next few years yet it trades at only 11x

We were out in Las Vegas last week and back for some more at G2E

Like BYI, IGT looks good heading into G2E but not necessarily for the same reasons.  We’re not sure IGT is going to deliver the same content wow factor as BYI will.  It’s not that IGT management wasn’t positive on its content for the show but who isn’t?  Our takeaways deal more with earnings visibility and growth, capital allocation, and a few upcoming catalysts.

  • Earnings – Obviously, management is not going to provide their earnings expectations but a line by line review of their business yielded good commentary about unit shipments, margins, and improving yields.  With Italy, Canada, and Ohio, unit shipments should be strong in FY2013.  Operating margin will be better sequentially in the September Q.  For 2013, there are some tailwinds.  Higher volumes will help product margins.  For gaming operations, margins will be aided by the depreciation schedule and conversions.  Obviously, the significantly lower share count will be very accretive.  The leveraging of the built out international infrastructure should benefit the margins of both segments.  Finally, gaming ops yields remain a concern.  However, management thinks they will cease to decline YoY in FQ3 of 2013 and while the September and December Q’s will likely be slightly negative YoY, they should look better than the YoY in the June Q.  We remain cautious on yields and are not sold on the content yet.  Obviously, management cannot control the economy or any caps put on the WAPs, but the fact is IGT’s content has lagged.  However, investor expectations for yields are pretty low and the other business levers are leaning positive.   
  • Capital Allocation – It’s very simple.  Current leverage of around 2.5x is the minimum that they will accept.  IGT generates strong free cash flow and there really isn’t anywhere else for them to put their cash (we hope!) other than buy back shares.  I suspect that they find the current price attractive for repurchase.
  • Catalysts – We are expecting a 10k unit order from Western Canada that has been awarded but not announced for political reasons.  IGT should get a good share of this and it will impact fiscal 2013 earnings.  Potentially more near-term, we think Goldman may be done with the accelerated share repurchase program soon.  Following completion, IGT will announce the results and, as we’ve been writing about, the number of shares repurchased will be more than expected.  IGT may also announce additional shares repurchased.  Overall, we would expect that announcement to be received positively.

Here are some details from our notes of the meeting:

  • No ASP issue but investors still concerned about that.  ASPs should be up in FQ4.
  • Game performance has been a yield issue for IGT – economy and competition as well
  • Product margins:  sequential improvement in September Q.  Same with Gaming Ops
  • 5 out of 6 yield buckets are up YoY
  • WAPs is the one category that is down
  • Pricing competition is fierce – cap on WAP is the most common
    • IGT is doing some of that but only in defense
  • Will be a positive announcement when Goldman finishes up the repurchase
  • International performance has been “good”.  Claim international share is growing and growing faster than the US.  Europe has been a drag.  
  • Projected low double digit growth for international in fiscal 2012 and it will be high single digits
  • Pretty much done with international infrastructure so should be able to leverage that
  • Should see flow from Atlantic Lottery Corp in September Q
  • Western Canada impact mostly in June and September 2013
  • IL: probably 50/50 for sale.  30k in shipments and IGT should get 45-55% share.
  • No boxes in Italy; games on Lottomatica boxes in early calendar 2013
  • Columbus – don’t know when it will be recognized
  • Canadian orders should help margins in 2013
  • FQ2 should be the first Q to have higher yields. There is a chance it happens in FQ1
  • 2.5x leverage right now.  This is probably the minimum and “wouldn’t go below that."
  • D&A and conversions are working in favor of IGT’s game ops margins for F2013.  Play levels will be a big driver.
  • F2013 should be a very good volume year
  • December NY Analyst meeting – we view this as management’s outlook is improving 
  • Will get 2013 guidance on November 8th