Are There Opportunities in the Toy Business?

Damian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market for toy companies remains challenging due to a variety of factors. So-called ‘age compression’ is affecting toy manufacturers, with electronic gadgets and games becoming more popular than toys. Toy companies have to sell their products before kids’ interests shift to other types of entertainment, or shift their focus to participate in the new industry.

Consolidation across the industry has also shrunk the retail market for toys as mass merchants have displaced specialty retailers. In addition, the rise of competition from private label toys has become a new threat for the big players while consumer confidence in the US and Europe continues to remain low.

Given these circumstances, let’s see how three players in the industry are performing.

Mattel, Inc.

Mattel (NASDAQ: MAT) is the world’s second-largest manufacturer of toys. It designs, manufactures and markets a variety of toy products worldwide.

The company’s first-quarter earnings per share grew year-over-year, driven by sales growth from the "American Girl" and "Monster High" brands and strong performance in Europe. Mattel is also enjoying a good position overseas, with international sales growing 9%.

Mattel is very focused on expanding its bottom line. Its Global Cost Leadership Program along with its cost-savings campaign Operational Excellence (OE) 2.0 managed to achieve cumulative cost savings of $187 million by the end of 2012. In addition, OE 3.0 will deliver an extra $150 million reduction by the end of next year. I highly support these successful initiatives.

With a leading position in the industry, Mattel possesses strong brand recognition due to its traditional category-leader toy brands such as "Barbie" and "Hot Wheels." In Feb. 2012 Mattel acquired HIT Entertainment, an entertainment distribution company which is poised to provide future growth opportunities due to toy license retention.

The company continues to optimize its entertainment partnerships as well. Its alliances with entertainment powerhouses like Disney, Dreamworks, and Nickelodeon will secure great sales figures in the future. However, the modest performance of the company’s leading "Barbie" brand and a weakness in its Fisher-Price core products remain potential concerns.

Hasbro Inc.

Hasbro (NASDAQ: HAS) produces children’s toys and family leisure time products with a range of portfolio of brands and entertainment properties. The company’s brand architecture identifies franchise brands, challenger brands, key partner brands and new brands.

The company’s first-quarter earnings of $0.05 per share increased 25% year-over-year, driven by top-line growth and an increase in the operating margins. Hasbro’s net revenue grew 2.2% to $663.7 million, including a $3.3 million impact from currency translations. Despite a moderate 4% net revenue increase in the US and Canada segment, its operating profit grew 162% to $37.7 million.

Hasbro is applying a long-term cost savings program that will ensure decent profitability. The initiative aims to provide $100 million in annual savings by 2015. In 2012, operating margins increased 15% in the US and Canada, despite a 6% decrease in sales.

The company’s strategic partnerships with gaming companies and lucrative product associations will guarantee Hasbro a good position in the future. Hasbro has broadcasting deals with Discovery, Cartoon Network and Mediaset in Europe. In addition, the company’s alliance with Electronic Arts will extend the brand further into the digital world. Digital gaming and casual entertainments is expected to grow substantially in the future.

I am concerned about Hasbro’s high exposure to Europe, however, a region that accounts for 28% of the company's revenues. Sales growth in the Euro-zone has been decelerating in the last couple of quarters.  

JAKKS Pacific, Inc.

JAKKS Pacific (NASDAQ: JAKK) designs, produces, markets and distributes toys, pet toys, consumables, electronics, kids indoor and outdoor furniture, and other consumer related products.

The company first-quarter results were very disappointing in spite of a significant 6.4% growth in revenue. Driven by a drop in sales and a margin contraction, the adjusted loss of $1.23 per share was considerably wider than the company's $0.59 loss a year ago.

The "Monsuno" line, one of the company’s major products, experienced a radical decline in its demand during the quarter. "Winx Club," another major brand for the company, suffered the same destiny. The increase in the company’s inventories during the last year confirms the low demand that JAKKS Pacific is experiencing.

JAKKS Pacific is being affected by a change in the pattern of kids play, and consequently its key products are lacking demand. The company is aware of this situation and is developing a breakthrough product line called "DreamPlay," which will be launched this fall. The impact of the new product line could be rather low, however, and will not materialize until the fourth quarter regardless. JAKKS Pacific will not launch any significant new products besides DreamPlay in the near term, so there’s no reason to expect higher returns anytime soon.

Bottom line

Mattel is a solid company. Its cost-saving efforts, along with its license partnerships and plans to expand abroad, make it worth the price to be in my portfolio.

Hasbro’s strong product line-up and operating margin increase give the company a good outlook for the future. Its strategy to expand into the digital world seems more solid than its competitors' and will reinforce the company’s position in the long run.

Due to the seasonality of the industry and the situation that JAKKS currently faces, I doubt that that the company will bring good results for next quarter. Hence, I would sell JAKKS Pacific.

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Damian Illia has no position in any stocks mentioned. The Motley Fool recommends Hasbro and Mattel. The Motley Fool owns shares of Hasbro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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