Hasbro's Q2 Shows Mixed Results, but with Upcoming Positive Upside
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The worldwide children’s/family leisure products (i.e. toys and games) industry has been a mixed bag thus far in 2012. On one hand, investors are experiencing an exciting shift within the industry, as a new generation of entertainment options is available due to the widespread adoption of smartphone and mobile device technologies. Similarly, the increased production of exciting blockbuster movie hits over the past several years allows for greater cross-promotion in other entertainment categories like action figures, board and digital games, and apparel and lifestyle products.
On the other hand, however, is the troublesome economic climate – a large slowdown in leisure/entertainment spending in mature European and North American markets, as well as the continual strengthening of the dollar are increasingly weighing down on earnings for all players within the industry. The worry of slower-than-expected growth in key emerging markets has implied that revenues from these markets may not make up for the losses taken elsewhere.
Hasbro’s (NASDAQ: HAS) second quarter of 2012 financial results perfectly illustrate this mixed bag. The corporation currently has some very exciting projects (and even more on the horizon), but global economic headwinds are preventing the toy manufacturer from realizing its full profitability potential.
Halfway Through 2012
Hasbro enjoyed a surprising 4% jump in its per share price on July 23 – on three times the average daily trading volume – despite not being completely in line with average analyst expectations. Although expectations called for a significant top line drop from last year’s $908.45 million, Q2 2012 revenues of $811.47 million were several percentage points short of the estimated $830.1 million. Hasbro experienced a meaningful drop in US/Canada revenues – down 20% year-over-year – yet a 15% increase in Latin America revenues prevented an 11% drop in Europe-based sales from completely crushing the corporation’s international business. International sales fell slightly less than 4% in the quarter.
Despite the top line struggles, Hasbro’s profitability-focused initiatives are paying off. Reductions in average inventory levels have acted as one of the drivers to more robust gross margins, which expanded nearly 320 basis points in the quarter to 61.6%. Similarly, profitability gains within Hasbro’s higher margin entertainment/licensing division are also receiving a multiplier effect by representing a higher proportion of the corporation’s top line. Driven by a 7.3% increase in operating profits for the quarter, EPS of $0.33/share beat estimates by a full $0.09/share.
More than Meets the Eye
One of the more meaningful impacts in Hasbro’s quarterly results was the large 16% drop in the sale of toys/games in the corporation’s “Boys” product category. The core Transformers line, which had very tough comps in Q2 2011 due to the timely release of Transformers: Dark of the Moon, experienced a harmful slump in the most recent quarter. The recent releases of Disney’s (NYSE: DIS) Marvel’s The Avengers and Sony Picture’s The Amazing Spider-Man have already had a positive impact of toy sales in those categories, and although they have yet to make up for the loss of Transformers-based sales, upcoming DVD releases for the 2012 holiday season are bound to maintain enthusiasm in the category for the remainder of the year.
Although the tough comps may induce a worrisome struggle in top line in the middle of 2012, there are some very enticing prospects in Hasbro’s mid-term future.
- Strong Film Slate
One of the most important tailwinds for Hasbro over the next several years is the huge support its toy/game lines will receive from upcoming film releases. Key among these is the continuation of the Avenger’s story line, with Iron Man 3, Thor: Dark World, and Captain America: The Winter Soldier throughout 2013 and 2014. The positive influence from these films cannot be downplayed – the first films in each of the series (two entries for Iron Man) have grossed a collective $2.03 billion in the worldwide box office, which is in addition to the $1.5 billion the characters collectively earned in this summer’s The Avengers film. With a contract to control Marvel rights through 2018, there is a huge amount of revenue to be earned from the sale of toys, digital games, and lifestyle in the category.
Two other film series offer a large potential for Hasbro as well. Fox’s The Wolverine is the direct sequel to 2009’s X-Men Origins: Wolverine ($373.06 million worldwide gross), which is in turn a shoot-off of the four film X-Men series (collective $1.5 billion worldwide gross). Similarly, an upcoming sequel to 2009’s G.I. Joe: The Rise of Cobra in Q1 2013 will provide a newfound excitement in Hasbro’s core G.I. Joe lineup.
- Licensing/Entertainment
The licensing of Hasbro’s key brands represents one of the most important growth platforms for the corporation in the future. Revenues from the division increased by nearly 60% in Q2 to $43.2 million, and total contribution from licensing/entertainment revenues represented 5% of total in the first half of 2012, up from around 3% in the same period in 2011. Hasbro currently owns 50% of a joint venture with Discovery Communications (NASDAQ: DISCA) – “The Hub” – which was recently nominated for eight daytime Emmy Awards for its various television shows. The company expects television related revenues to hit $300 million in 2012. Similarly, Hasbro recently announced a deal to provide Netflix with 10 shows for streaming customers. Both 1980s classics like the Transformers and G.I. Joe animated series, as well as modern remakes of the originals, will be available to Netflix’s 23.4 million domestic streaming consumers by the end of 2012.
- New Products
It is difficult to imagine that many people could forget the Furby craze of the late 1990s – more than 40 million units of the interactive toy were sold over a three-year period starting in 1998. Furby is back in 2012, and is a huge improvement upon its prior generation. With more packed-in technology and add-on apps for iOS and Android devices, the new Furby is already on the top Christmas toy list for the upcoming holiday season and is expected to be a huge seller among the latest generation to grow up alongside the rise in smartphones and tablets.
Hasbro has also recently announced a licensing deal with Zynga to produce physical versions of the latter’s popular FarmVille, CityVille, and Words with Friends social games. Zynga announced that its popular games attracted 292 million average monthly active users in the most recent quarter, up nearly 25% compared to Q1 2011.
Headwinds and Tailwinds Collide
With the combination of a strong film slate, new distribution deals for television and streaming content, and new physical toys among several different categories, Hasbro is arguably facing one of the best product portfolios it has enjoyed over the past decade. Despite the tailwind strength, a continued challenge from foreign exchange losses and a less-than-stellar domestic and European economy will continue to weigh down on upcoming earnings.
It can be argued, however, that the positives do outweigh the negatives. European-based sales are holding up decently, with first half 2012 sales being on par with the revenues generated in the same period in 2011. Swiftly growing sales in Eastern European markets like Russia and in Latin America (sales up 17.1% in first half 2012) are likely to make up for most of the losses experienced in weaker economies like Spain/Italy/Greece. Likewise, the corporation has taken proactive steps to boost profitability – reducing overall inventory levels to focus on core product categories and shifting a small percentage of sales to higher volume quarters to more closely match consumer demand.
With earnings estimates for $2.84/share and $3.06/share in 2012 and 2013, respectively, Hasbro’s forward P/E of 11.4x is more than 20% below its past five year P/E average. Based on the number of upcoming catalysts, especially from the continued popularity of The Avengers heroes, it might be time for investors to take a closer look into Hasbro shares.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney and Hasbro. Motley Fool newsletter services recommend Hasbro and Walt Disney. 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. If you have questions about this post or the Fool’s blog network, click here for information.
