How to Play the Toy Industry

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

The thing about the toy industry is that it has continued to thrive despite a tough economic environment, outperforming the S&P 500 nicely over the last twelve months. 

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I think toymaker Hasbro (NASDAQ: HAS) might still have room to go higher, and eventually outpace chief competitor Mattel (NASDAQ: MAT)Hasbro posted first quarter earnings of $0.05 cents per share, one cent above estimates, on the back of $663 million in revenue, also topping expectations for $639 million. 

Another great thing about Hasbro is its 3.35% dividend yield. Hasbro's well-known brand names include Transformers, NERF, My little Pony and Monopoly. The other great toymaker, Mattel, has brands that include Barbie, Hot Wheels, Matchbox, Toy Story, WWE Wrestling and Batman.

One of the big headwinds for Mattel is the transition from toys to electronic gadgets and games. Yet, one of the big initiatives for Hasbro is the fact that the company is forming strategic partnerships with gaming companies. This includes its multi-year strategic agreement with Electronic Arts

I like Hasbro's greater focus on entertainment, and the once weak games and puzzle category, which is yielding growth through several partnerships. The company has a cost savings program to deliver $100 million in savings annually by 2015, which includes a 10% reduction in workforce, facility consolidation and the implementation of process improvements.

On the other hand, Mattel has been focusing on building new franchises and optimizing entertainment partnerships. Mattel has alliances with entertainment powerhouses like Disney, Pixar, Warner Bros. and Nickelodeon. One plus for Mattel is that it recently renewed its multi-year global licensing partnership with Nickelodeon in March 2012 to develop toys based on Nickelodeon s pre-school programs.

Even still, Hasbro is on its heels, also seeking to expand its brand to television. Hasbro has a 50% interest in a joint venture with Discovery, The Hub, which operates a TV network in the U.S. The other notable headwind for Mattel is its core Fisher-Price brand. The segment was down considerably in 1Q 2013 and management has no plans to put out new products before the second half of 2013.

The hedge fund trade

Going into 2013, Hasbro had some of the best increased hedge fund interest, where there was a 25% increase in hedge funds owning the stock from the third quarter. This includes its top hedge fund owner Tom Russo's Gardner Russo & Gardner and number two owner, billionaire Israel Englander's Millennium Management. 

At the end of 2012, there were a total of 22 hedge funds long the Mattel, compared to Hasbro's 15, but the increase was only 16% from the third quarter. Billionaire Ken Griffin's Citadel Investment Group had the most valuable position in Mattel, worth close to $50.9 million, but making up a mere 0.1% of its total 13F portfolio. 

Disney (NYSE: DIS), known for its amusement parks, is actually a media giant. Its largest segment (46% of revenues) includes domestic broadcast television, television production, cable networks, operating the ABC Television Network and the ESPN and Disney Channel cable networks.

Meanwhile, it does operate in the toy industry via its consumer products segment, which engages manufacturers and retailers to design, develop and sell a wide variety of products based on existing and new Disney characters and other intellectual property. One positive was that consumer products revenues increased 7% last quarter year over year, while segment operating income rose 11%. However, this segment still only makes up 8% of revenues.

As a company, Disney has been increasing its spending in parks and resorts, which could put pressure on margins in the near term. The media company also has a heavy reliance on advertising revenues, which also happens to be heavily tied to the macro-economic environment. Disney, being a relatively diversified media company, has managed to attract serious hedge fund investors. Mason Hawkins' Southeastern Asset Management is the top hedge fund owner by shares, with nearly 4% of their portfolio invested in the company as of the end of 2012. 

By the numbers

Hasbro has the most impressive dividend, while also managing to grow its dividend payment the most:

<table> <tbody> <tr> <td> </td> <td> <p>Hasbro</p> </td> <td> <p>Mattel</p> </td> <td> <p>Disney</p> </td> </tr> <tr> <td> <p>Dividend yield</p> </td> <td> <p>3.35%</p> </td> <td> <p>3.27%</p> </td> <td> <p>1.22%</p> </td> </tr> <tr> <td> <p>5-year annualized dividend growth</p> </td> <td> <p>20%</p> </td> <td> <p>14%</p> </td> <td> <p>16.5%</p> </td> </tr> </tbody> </table>

Meanwhile Hasbro is also the cheapest:

<table> <tbody> <tr> <td> </td> <td> <p>Hasbro</p> </td> <td> <p>Mattel</p> </td> <td> <p>Disney</p> </td> </tr> <tr> <td> <p>Price to earnings</p> </td> <td> <p>18.3</p> </td> <td> <p>19.2</p> </td> <td> <p>20.1</p> </td> </tr> <tr> <td> <p>Price to sales</p> </td> <td> <p>1.43</p> </td> <td> <p>2.32</p> </td> <td> <p>2.60</p> </td> </tr> </tbody> </table>

Don't be fooled

The tailwinds for the industry include the fact that consumer spending should increase on the back of a rebounding economy. However, it appears that Hasbro might be able to outperform the competition with its leading dividend yield and cheap valuation. 

Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Hasbro, Mattel, and Walt Disney. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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