International Gaming Technology Stock (NYSE:IGT) have been a solid performer over the past year, growing by around 10%. However, they have fallen over 10% in recent months, given some consumer health concerns that could weigh on the gaming industry. dynamics. IGT is performing well, expanding margins, strengthening its balance sheet and looks poised for continued growth. At less than 10x free cash flow, I see the stock as attractive.
In the company the third trimesterit earned $0.52 in adjusted EPS, $0.04 ahead consensus, while revenue of $1.06 billion beat estimates by 3%. Excluding its sale in Italy, revenue was up 4% from last year. The company generated 21% EPS growth thanks to continued margin expansion efforts. Operating income rose 10% to $239 million while margins expanded 220 percentage points, thanks to improved R&D discipline, supply chain improvements and normalized results in its digital business after a purchase. Importantly, management expects continued margin growth through 2025.
IGT operates in three segments. First, lottery revenue rose 5% to $601 million thanks to strength in the Powerball and Mega Millions games, as well as growth in Italy. This marked the third quarter with EBITDA margins above 50%. IGT essentially provides services to help jurisdictions run their lotteries, receiving a share of the revenue in accordance with the level of ticket sales. In the quarter, instant ticket sales rose 0.2%, while multi-state jackpots rose 25.2% for 3.1% compounded growth, given how weighted the business is to instant sales.
Sales in many states may be inconsistent, depending on the size of the jackpots. The higher the Powerball and Mega Millions jackpots, the more ticket sales tend to accelerate—we’ve all witnessed the media and social frenzy when these jackpots approach or exceed $1 billion, attracting more gamblers. random. There is a quarter-by-quarter luck rate on how long the games go without a winner, increasing the jackpot, although changes to the games over the years have reduced the odds in an effort to make big jackpots more likely.
Interestingly, this part of the lottery business benefits from higher interest rates. The image below is from Powerball. The advertised jackpot represents the payout if you decide to take the jackpot over 30 years, rather than today’s cash value. This future payment is linked to the level of interest rates (similar to an annuity). Higher rates than a few years ago means the same cash value leads to a bigger title jackpot. Given that bigger jackpots tend to attract more buyers, the fact that higher fees are making jackpots bigger than they were before should support continued buying activity, all else equal.
It is also worth noting that the lottery business is quite non-cyclical. In recessions, growth often slows, but historically, we have not seen declines in the US. While lottery spending is completely discretionary, it is cheap and consumers tend to continue with their existing spending routine even in weaker economic conditions. In Italy, where IGT has a large lottery business, it has been a bit more cyclical (the COVID business closures were also more of a headwind in 2020, but this should not repeat itself in typical recessions), but again, the business is quite stable.
This business is supported by long-term contracts with lottery organizations, ensuring a secure cash flow in the future. IGT has one 6 years remaining life on lottery contracts, based on revenue weighting. During the quarter, IGT signed contracts with California, extending this relationship through 2033 and with Kentucky through 2036. The longevity of its contracts and continued history of re-signing with major counterparts provide an attractive and stable business profile .
Then, IGT’s gaming revenue rose 8% to $403 million. This unit sells slot machines and other casino machines. Its installed base rose 1% to 52,627 units. This leads to ongoing software sales as it provides updates and licensing for its games, creating a high-margin recurring revenue stream. In line with that, operating margins increased by 550bp as the company streamlined R&D, has lower supply chain costs and is picking up more system and software sales. Operating income was 23%; IGT has a 2025 target of 28-30%. Basically, it is halfway to the target margin improvement. At that level, the company’s free cash flow will increase by another $60 million a year.
In the quarter, IGT shipped 9,158 units. ASP fell slightly to $15,100 due to a less favorable mix. 586 of its units shipped were new, and the rest were replacements. Now, this segment is more exposed to the economy as it is tied to casinos choosing to refresh machines. In a downturn, they may try to extend the life of their cars. I will note that US hardware sales are less than $5 billion, which is only a reflection of the $124 billion spent in casinos. last year. This is not a major way for casinos to cut costs.
Moreover, at the moment, casinos are seeing growth. Last quarter, gross gaming revenue rose 6%, with growth across the board.
For all focus on online sports betting (not running IGT’s business); according to American Gaming Association, Q3 set a new record in physical gaming. This is the market that IGT’s gaming unit is serving, and so this strong level of consumer spending should support continued spending by casino operators on machines. The background remains favorable.
Indeed, as a result of a strong backdrop, a net 22% of gaming executives expect to spend more on capital investment in the coming months. As a result, 11% net expect to see continued growth in gaming unit operations. This should translate into more machine sales for IGT, further increasing the installed user base and paving the way for higher future software and system sales in the coming years.
Additionally, I will note that IGT receives 80% of its gaming revenue from regional operators. Las Vegas is a small part of his business, as casinos everywhere need machines. If we see an increasing number of casinos, this creates natural growth opportunities for IGT to increase gaming revenue as new casinos fill their floors with slots and machines. Importantly, some states are looking to do just that as they seek new forms of tax revenue. New York has created licenses for three new casinos. Bally’s (FRONT TABLE) just opened that temporary Chicago location, while the larger, permanent one will open in 2026. While these projects will take several years to complete, incorporating casinos into major metro centers offers medium-term growth for IGT’s business, beyond the regular cycle of improvement.
Finally, digital gaming was flat at $55m, but margins increased by 660bp as iSoftBet integrated and benefited from IGT’s greater scale. With streamlined costs and this fully integrated unit, there should be room for growth given the growth in online gaming. The flat production here is disappointing, and as such, I’m not assuming material revenue growth, rather I’m assuming this unit remains flat until proven capable of growth.
Finally, the company has brought net leverage to an all-time low of 3x, a prudent move in today’s higher interest rate environment. IGT has $600 million in unrestricted cash and just prepaid $112 million of debt due 2024. As you can see below, it has no major maturities until 2025. This provides some insulation from the current rate environment of interest. I see its net debt of $5.25 billion as very manageable.
With strong margin expansion, IGT was able to generate $324 million in free cash flow and $509 million in adjustments for one-time items. Alongside the results, management said that in the fourth quarter it expects about $1.1 billion in lottery revenue between the single digital home and gaming. Therefore, for the full year, revenue will be at the high end of the previous range, or about $4.3 billion.
This will translate into approximately $600 million of normalized free cash flow. At the current share price, IGT has an 11% free cash flow yield. Its lottery business should be able to generate low-single-digit growth in line with nominal economic activity, while its gaming unit should enjoy somewhat faster growth, especially as it continues to benefit from higher sales of software and some new casino openings. With further margin expansion, IGT should be a $700 million free cash flow business in 2025 assuming no growth in digital. With a 10% free cash flow yield in 2025, the stock has about 31% upside to $35 over the next two years. Combined with the 3% dividend yield, investors have a potential two-year annualized return of around 17%. That’s compelling for a company with significant long-term contracts, improved debt metrics and modest growth. In my opinion, IGT is a good stock to bet on for value-focused investors.