We have downgraded International Game Technology Inc. (IGT) to Underperform from our previous Neutral rating since replacements of gaming machines are likely to remain weak over the next year. We lower our price target to $13.00, indicating that the company would perform below the broader market.
 
Moreover, a continued lack of visibility for replacement demand,  impact of interest rates on Gaming margin, weak casino budgets and lower spending plans for 2010 have led analysts lower their revenues and earnings per share (EPS) estimates for fiscal 2010.
 
EPS estimate for the fourth quarter 2010 (current quarter) has fallen by 13.6% in the last three months to 19 cents. EPS estimate for the full year has been decreased by 4.5% to 84 cents since the last quarter.
 
Moreover, the highly leveraged balance sheet, pullback in spending by gamblers and a strong competition from Bally Technologies Inc. (BYI) and WMS industries Inc. (WMS) are areas of concern.
 
IGT is a leading manufacturer, designer, producer and marketer of computerized casino gaming equipment, systems and devices worldwide. A protracted decline in capital spending to purchase or lease gaming equipment by casino operators would result in slower sales of new devices and lower replacement of gaming devices, curtailing the company’s growth and expansion plans.
 
On a positive note, focus on core activities, cost containment efforts, substantial free cash flow, increased international penetration and new gaming operations titles will drive growth.
 
Third Quarter 2010 Highlights
 
IGT’s third quarter 2010 earnings were in line with the Zacks Consensus Estimate. However, revenues and margins were below the Consensus Estimate due to weak results from gaming operations and product sales, partially offset by cost cutting measures.
 
Earnings, excluding one-time items, decreased 8.7% year over year to 21 cents per share in the quarter.
 
Revenues dropped 5.3% year over year to $489.7 million from $517.3 million in the third quarter of 2009. Revenues were well below the Zacks Consensus Estimate of $503.0 million. Gaming operations contributed 57.0% to total revenue whereas product sales accounted for the remaining 44.0% of the revenues.
 
Gross margin decreased 90 basis points to 56.3% in the reported quarter. Stringent cost control resulted in a fall in operating expenses, which slid 8.0% year over year to $155.7 million, in sync with management’s expectations. As a result of cost-reduction efforts and lower professional service fees, IGT expects cost savings of $200.0 million. Operating margin decreased 10 basis points to 24.5% in the quarter.
 
Outlook
 
Management apprehends a continued lack of visibility for replacement demand, revenue recognition risks associated with a few significant transactions, weak casino budgets and spending plans for 2010 and the impact of interest rates on Gaming Operations’ margin. International Game now expects earnings per share to be in the range of 82 cents to 85 cents versus previous expectation in a range of 77 cents to 85 cents. The guidance is in line with the Zacks Consensus Estimate, which calls for 84 cents per share in earnings for fiscal 2010.
 
Currently, IGT has a Zacks rank of # 3, which implies a short-term Hold rating (for the next 1-3 months). Over the long term (6-12 months), we have an Underperform recommendation on the stock.
 
BALLY TECH INC (BYI): Free Stock Analysis Report
 
INTL GAME TECH (IGT): Free Stock Analysis Report
 
WMS INDS INC (WMS): Free Stock Analysis Report
 
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