In its latest Q4 earnings report, IGT blamed a stingy customer base for a 4% fall in full-year earnings to $2.6 billion, with lower play and a shift in product mix cited as the primary culprits for the top-line deterioration.
It would be nice if a weak macro-environment was all IGT had to worry about, but it may be stuck with stagnant sales for the foreseeable future. That’s because a high percentage of IGT’s machines are based on aging legacy products. As a result, it is working to push more advanced games based on its Advanced Video Poker (AVP) and similar products based on server-based technologies that allow casino customers to better control their gaming floors with the enhanced flexibility of network functionality and ability to introduce new-and-exciting games more quickly.
IGT has been criticized for taking too long to shift its games to newer platforms, and this has allowed nimbler peers such as Bally (NYSE:BYI) and WMS Industries (NYSE:WMS) to eat into IGT’s market leadership position. These tough business trends are also eating into profitability, with management highlighting “technological obsolescence related to the transition to new products” as a key reason for the 33% drop in full-year earnings.
Best Horse in a Weak Field
IGT’s outlook certainly sounds grim, and the fact it just posted full-year earnings below what it reported back in fiscal 2003 is definitely alarming. But the shares have likely suffered enough to fully account for the challenges the company faces. At current levels the stock trades for under 12 times the $1.10 reported earnings for fiscal 2008 and under 10 times the consensus analyst estimate for the coming year.
And despite the tepid outlook, IGT has a number of levers it can pull to improve operational performance. During the earnings conference call, CEO Thomas Matthews spoke to the need to reduce operating expenses by more than $100 million annually to offset for flagging sales growth, which will be achieved through layoffs. There is also quite a bit of anticipation surrounding the introduction of IGT’s server-based system when MGM’s massive City Center project opens in late 2009. (To learn more about how to interpret the income statement, read Understanding The Income Statement.)
It also spends massively on research and development, with 9% ($223 million) of last year’s sales spent on developing new games and technology. To put that into context, that’s more than Bally and WMS reported in net income put together over the past twelve months. IGT also remains solidly profitable, with net margins currently coming in at 14%. That leaves plenty of room to continue to buy back stock and pay dividends; the dividend yield currently stands at 4.1%. (To learn more about dividends, read The Importance Of Dividends.)
Does The House Always Win?
There is no doubt that the economy and uncertainty regarding the way gaming systems will be sold will continue to weigh on IGT. But gamblers will eventually return, and there could be plenty of benefits as the industry shifts from selling traditional, self-contained hardware to products that are based more on software and network systems. IGT itself is more of a gamble these days, but it looks to be worth the risk at current levels given it still dominates an industry with plenty of long-term appeal.