Why Shuffle Master Is Better Positioned Than The Casino Operators

| About: SHFL entertainment, (SHFL)

Gambling game supplier Shuffle Master (NASDAQ:SHFL) reported weaker-than-expected third-quarter results. Revenue increased 9% year-over-year to $63.4 million, several million short of consensus estimates. Earnings per share grew just 6% year-over-year to $0.18, a few cents short of consensus expectations.

Though revenue growth was slightly disappointing, we were very encouraged to see recurring revenue advance 12% year-over-year to $30 million, marking its 15th consecutive quarter of expansion. Further, gross margins increased 100 basis points compared to last year to 63% thanks to more leases and higher average selling prices. Total utility revenue increased 8%, to $24.4 million, driven largely by strength in Macau and increased leases in the United States. The MD3 continues to spread thanks to superior card scanning abilities and greater operating speed.

Proprietary table games also continue to perform well, with 18% revenue growth during the third quarter on a 17% jump in recurring revenue. Gross margins in the segment were a whopping 82%. As the installed base continues to grow, we think users will become bigger fans of the firm's product portfolio, which could lead to compounding revenue growth in the years ahead. Electronic gaming machines continue to follow a similar path, growing 11% year-over-year during the period, though gross margins weakened as a result of a decline in average selling prices from a large sale in the Philippines. We see a similar compounding scenario for this segment, especially as users become bigger fans of visual entertainment.

We expect municipalities in the U.S., plagued by debt and lower tax receipts, to continue to legalize more casino licenses, which may be bad for Las Vegas, but will likely be good for Shuffle Master. Asia also looks like an attractive long-term growth market as the emerging middle-class continues to grow. After generating free cash flow of nearly $12 million in the quarter, Shuffle Master now has a net-cash position for the first time in 8 years. We like the company's dedication to paying off debt and wisely investing capital in research and development for long-term growth. We think the casino supplier is better positioned than casino operators themselves--such as MGM (NYSE:MGM) and Las Vegas Sands (NYSE:LVS)--as competition in the casino space will continue to heighten over the long term.

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