Thursday 24 January 2019 Charlie’s back! Charlie’s back and we are so glad he’s had his sabbatical and resumed his involvement in the Switzer Report and other things we do here at Switzer, such as the next webinar on Friday 1 February. Today Charlie has an update on Aristocrat Leisure and believes we could see a retest of the December lows over the next few months, which could be a tremendous buying opportunity in high quality long duration companies that are rarely on sale. On that basis, he says he is holding some cash, waiting to deploy at lower prices with what he calls a “shopping list” of great companies he hopes to buy with a “margin of safety”. Sincerely, Peter Switzer Inside this Issue 02 Why I’m buying Aristocrat Leisure Why I’m buying ALL by Charlie Aitken 05 5 reasons why I like Invocare Big headwinds by Tony Featherstone 08 Stock of the Week – Xero Limited (XRO) Xero Limited by Michael Wayne Why I’m buying 10 Buy, Hold, Sell - What the Brokers Say Up and downgrades! Aristocrat Leisure by Rudi Filapek-Vandyck by Charlie Aitken 15 Questions of the Week – Franking credits, a LIC and an 02 ETF Franking credits, a LIC and an ETF by Paul Rickard Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No. 286 531 acting, consider the appropriateness of the information, having regard to the Level 4, 10 Spring Street, Sydney, NSW, 2000 individual's objectives, financial situation and needs and, if necessary, seek T: 1300 794 893 F: (02) 9222 1456 appropriate professional advice. Why I’m buying Aristocrat Leisure by Charlie Aitken After a volatile 2018, which ended in an aggressive stock fell -36% from its peak. global equity market sell off, it’s nice to turn a new leaf in 2019 and search for stocks that have the potential to generate us double-digit returns from current depressed prices. The most interesting aspect of the December 2018 sell off was it became indiscriminate by stock and sector. Virtually nothing was immune to selling pressure in the last few weeks of 2018, a market phenomenon that’s often associated with a sentiment capitulation bottom. That is a clear P/E de-rating back to 17.8x FY19 As we have seen, markets have bounced solidly from consensus estimates, the same estimates that those December lows, but I’d have to say you forecast 19% EPS growth. ALL is now trading back generally don’t get a true market bottom until the on a price to growth ratio of less than 1x, which I market itself “returns to the scene of the crime”. I believe will prove an attractive entry point. believe we could see a retest of the December lows over the next few months and that would be a The P/E de-rating was really about the uncertainty of tremendous buying opportunity in high quality long ALL’s large scale digital investments. Markets hate duration companies that are rarely on sale. uncertainty, but particularly so when they see back-to-back large scale acquisitions, albeit in an On that basis, I am holding some cash, waiting to area of competence from the given company. This deploy at lower prices with what I would call a combined with a “momentum” investor register led to “shopping list” of great companies I hope to buy with an overly-aggressive de-rating. a “margin of safety”. It will pay to be a little patient I suspect, but when the moment comes at the right risk However, we are now starting to get a little clarity on adjusted price, you must act and put cash to work. ALL’s digital investments. The news is incrementally positive and that is all you need in a stock that has One of the stocks on my “shopping list” is Aristocrat been heavily over-sold. A little clarity helps. Leisure (ALL.ASX). ALL is one of my core portfolio holdings and its underperformance was a detractor The Eilers social casino tracker for the December from our portfolio performance in the second-half or 2018 quarter (Aristocrat’s 1Q19) was released in the 2H of 2018. US last week. I am going to quote directly from Evans & Partners research that succinctly summarised the The 2H de-rating on ALL was driven mainly by small event. earnings downgrades in a stock that was heavily owned by momentum investors. The chart below Aristocrat social casino pro-forma revenues (Product confirms that consensus FY19 EPS estimates have Madness & Big Fish) were estimated to have grown: fallen by -4.31% over the last six months, yet the Thursday 24 January 2019 02 7% year-on-year (PM 12.3% and BF 21.3%) vs. 12.9% year-on-year in the September 2018 quarter. 4% quarter-on-quarter (PM 0.8% and BF 6.2%) vs. 4.4% quarter-on-quarter in the September 2018 quarter. Aristocrat’s market share was 12.73% vs. 12.67% in the September 2018 quarter. Source: Evans & Partners Aristocrat remains the clear number 2 in the market. This is a positive result for Aristocrat for 5 reasons: The overall social casino market grew: 1. Aristocrat social casino revenue growth improved in the Dec quarter and is on track to 9% year-on-year vs. 12.1% year-on-year in comfortably meet FY19 growth forecast of 8% the September 2018 quarter. year-on-year. 9% quarter-on-quarter vs. 0.7% 2. Aristocrat social casino revenues continue to quarter-on-quarter in the September 2018 grow above market. quarter 3. Aristocrat’s multi-app strategy is proving The top 5 operators comprised 63.8% of successful with new apps (Lightning Link from revenues in the December quarter, up 120bps Product Madness, Jackpot Magic from Big , but down 10bps quarter-on-quarter. Fish) more than offsetting softer numbers CY2018 revenues of US$5.193 billion were from flagship apps (i.e. Heart of Vegas). largely in line with expectations; Eilers market 4. The overall market continues to grow strongly. growth estimates are largely unchanged 5. The top 5 operators continue to maintain (CY2018-22 CAGR of 7.5%). dominant market shares, controlling 64% of the market. Industry trends: Active users declined in 2018 (DAUs declined 4% in CY18) However, this was more than offset by strong yields (ARPDAU up 18% in CY18) Acquisition costs were surprisingly down in the Dec quarter (Cost per install or CPI) NOTE: The Eilers social casino tracker revenue data is derived from average gross ranking position on the iOS and Google Playstore, 3rd party data, and Source: Evans & Partners proprietary estimates. The report’s estimates have historically been highly correlated with company Most of the industry analysts have seen the data now reported social casino revenues. and have made constructive comments about it. Some suggest the run rate is ahead of their expectations and may lead to small earnings upgrades. This is important as it suggests the small ALL earnings downgrade cycle, that triggered the heavy sell off, is over. ALL stock rose +3.1% on the first day after the US social casino data was released. ALL shares hit a low of $20.66 on Christmas Eve 2018. The technical relative strength index (RSI) Thursday 24 January 2019 03 bottomed that day at 25, an oversold reading. Since then, the stock has regained the 50-day moving average at $23.68, and through time should regain the 100-day moving average at $26.11 and eventually the 200-day moving average at $27.87. This recovery won’t be without volatility but I will be looking to use weak days to accumulate ALL stock, as I genuinely believe the worst is behind it now both fundamentally and technically. It’s also worth noting around 30% of the register has changed hands in the last six months, which suggests weak holders have exited the stock. Interestingly, the analysts community remain bullish on ALL. There are 11 buys, 2 holds and 0 sell recommendations and the median 12-month price target is $31.19. That would be a +28.3% gain if proved accurate. I realise some people have ethical issues with owning gaming stocks or those who manufacture gaming software. I do have sympathy for those views as the social cost of problem gambling is enormous. However, the company operates in a highly regulated market and my job as a fund manager is to invest in the best-of-breed companies in structurally growing industries. ALL fits that description. As I said earlier in this note, I do believe a broader better buying opportunity will emerge again in equity markets over the next few months. I feel ALL trading on a PEG ratio less than 1x will be a good place to put some cash to work into a broader market pullback. That’s my final point today: this is going to remain volatile. I don’t believe there’s any great rush to do anything and that patience in times of volatility will be rewarded. Wait for your moments to act: they will come. Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.