Don't Play With That

By Chad Henage - October 20, 2012 | Tickers: HAS, MAT, DIS | 0 Comments

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It must be frustrating being a company with an iconic brand name that still can't quite beat your competition. However, that seems to be the case at Mattel (NASDAQ: MAT). The company owns brands like Barbie, Hot Wheels, Fisher-Price, and more, and yet each quarter they seem to be playing at a disadvantage to Hasbro (NASDAQ: HAS). It's actually not a very fair fight, when you pit Barbie against the Avengers, Barbie doesn't stand a chance. While Mattel reported okay results in its most recent quarter, there are partnerships in place with Hasbro that make it appear that Mattel is going to be playing second fiddle for a while.

Everyone knows in the toy industry that manufacturers are biding their time until we get to the holiday selling season. For Mattel this last three months has to be considered somewhat of a victory considering they were able to report decent sales growth. For the quarter, the company showed 4% sales growth, and actually without foreign currency adjustments sales would have been up 7%. On the surface the company's EPS growth of over 20% looks like a big win for the company. However, when you look at the company's main divisions, sales growth just didn't live up to expectations. The company has said in the past that they expect their “core brands” like Barbie, Hot Wheels, Fisher-Price, and American Girl to drive sales. They also said they expect International sales to help drive the top line in the future. While organic International sales did their part, only part of the company's core brands performed like the growth drivers they could be.

Mattel showed respectable sales in the U.S. with a 6% increase. International sales on the surface don't look that good at just a 2% increase, but without currency adjustments, sales would have actually increased 11%. This is exactly the type of strong top-line growth the company needs to drive results. However, only two of the four “core brands” for the company showed good results. American Girl sales led the way with a 16% increase, followed by Fisher-Price, which reported sales up 6%. However, the iconic Barbie line showed sales down 4%, and Hot Wheels sales were flat on a year-over-year basis. The company's financial statements show investors a company that is struggling with consistency.

While investors I'm sure are happy that Mattel repurchased about $5 million in stock at an average price of $35.97, I'm not sure the company should have made these purchases. If you look at the cash flow situation at the company you would never know that Mattel reported 20% higher earnings per share. Over the last nine months, the company showed operating cash flow of negative $101 million. As proof that Mattel is having trouble generating enough cash for capital expenditures, the company's balance sheet has gotten much weaker in the last few months. In fact, though cash on the balance sheet is up $27 million, long-term debt has increased by $250 million. When a company is showing negative operating cash flow, and their long-term debt increases by more than 20%, share repurchases look like a bad idea. This is really where investors can find the haves and the have nots in the toy industry.

When you look at Mattel and Hasbro side-by-side, you begin to see the advantages that Hasbro holds over their competition. Hasbro has more what I would call “movie ready” characters with Transformers and G.I. Joe. We have seen this play out with multiple successful Transformers movies, and G.I. Joe obviously holds promise as a new movie is currently in production. When it comes to Mattel their most movie ready character is Barbie, but unfortunately you aren't likely to see much from Barbie that isn't the straight to DVD type of film. There are two other big licensing deals that benefit Hasbro. First, the company has the license to the Sesame Street lineup of characters. For anyone with a young child they can tell you first hand the amount of money parents spend on Elmo, Ernie, Big Bird, and the like. Second, and this is a critical win for Hasbro is, their licensing agreement with Walt Disney's (NYSE: DIS) Marvel franchise.

I would make the argument that as long as Hasbro holds the Marvel licensing agreement that this alone makes Hasbro a better deal than Mattel. With multiple big releases of Captain America, Thor, Iron Man, and The Avengers, the public already has shown an affinity for these characters. This is a big win for both Disney and Hasbro as they both make money the more popular these toys, games, and films become. Disney wins because they have a good lineup of upcoming releases that play off of the Avengers characters. With films sequels to Captain America, Thor, Iron Man, and Avengers 2 all expected over the next few years, Disney will benefit from higher box office receipts. Hasbro, as the licensee for these characters, has the chance to utilize the popularity of the characters to offer updated toys each time a new movie is released. The Avengers characters create a well defined money train for both Hasbro and Disney, and Mattel is left out in the cold. When it comes to cash flow, this is yet another reason to avoid playing with Mattel and switch to either Hasbro or Disney.

Given three choices, you tell me which one sounds best?

1. This company pays a yield of 3.7%, has a 52% free cash flow payout ratio and licenses some of the top toy names for feature films.

2. This company pays a yield of 1.15%, has a 22% free cash flow payout ratio, owns a movie library second to none, should benefit from the licensing of its characters for multiple upcoming movies, and also owns theme parks, and a cruise line.

3. This company pays a yield of 3.32%, has shown negative free cash flow this year, a 67% free cash flow payout ratio last year, and is showing lackluster growth at two of its four major toy brands.

There should be little argument that company number 1 or 2 would be the best investment. Company number 1 is Hasbro, company number 2 is Walt Disney, and company number 3 is Mattel. Given the results, and the alternatives, I just don't see a reason to pick up and play with Mattel.

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