Is This Toy Maker a Buy?

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

The U.S. toy market is dominated by two companies:  Hasbro (NASDAQ: HAS) and Mattel (NASDAQ: MAT).  Hasbro is the smaller of the two.  Hasbro has a $4.5 billion market capitalization, whereas Mattel’s market value stands at roughly $12.5 billion.  Hasbro has a product portfolio that most consumers would easily recognize:  games including Monopoly and Scrabble, and toy brands including Nerf and G.I. Joe.  Both Hasbro and Mattel have similar valuation profiles:  each has a relatively modest price-to-earnings ratio and both pay good dividend yields to shareholders.  Hasbro has had a bumpy ride the last two years.  The stock reached a high of almost $50 per share in late 2010, only to drop steadily since, to its current level of $36.  Therefore the question remains—is Hasbro set for outperformance in 2013?

Competitive Pressures

The primary reason for the stock’s decline seems to be its struggles to improve sales in the midst of an extremely competitive toy industry.  Through the nine months ended Sept. 30, net sales at Hasbro have declined just over 5 percent, year over year.  A reason for this could be that tablets and other mobile devices have begun to cannibalize sales of traditional games and toys.  Online games such as Zynga’s (NASDAQ: ZNGA) Farmville may be eating into Hasbro’s sales.  Zynga reported sales of its online games increased over 11 percent through the same period.  Zynga's market cap now stands at over $2 billion.  Larger rival Mattel seems to be navigating the trend towards mobile gaming better than Hasbro, as its sales during the nine months ended Sept. 30 increased 1.2 percent.

Whether Hasbro can reverse this decline in sales is unclear.  The popularity of online gaming could be a fad, or possibly the beginning of a more permanent trend away from traditional toys and games.  Consumer tastes, particularly those of children, are unpredictable and often change quickly.

Stock Valuation

If Hasbro can get sales increasing again, the company looks to be in sound financial condition.  It’s certainly not expensive, with a trailing price-to-earnings ratio of just over 13.  In addition, toy makers such as Hasbro and Mattel derive the vast majority of their annual sales from the critical fourth quarter—meaning a successful holiday sales season could more than counteract the decline in sales through the first nine months of the year.

It’s fairly clear the company is priced for little to no growth going forward.  The forward P/E for Hasbro is only 12.  If the company can demonstrate a return to sales growth, higher earnings and a higher multiple should soon follow.  Next year’s earnings are expected to be $2.98 per share.  It would be entirely reasonable for Hasbro to be a $40 stock if the company shows increasing sales going forward, considering the company’s brand strength, strong cash flows and commitment to rewarding shareholders.

To that end, Hasbro has demonstrated a clear intention of paying dividends to shareholders, and raising those dividends regularly.  Hasbro paid dividends totaling $0.80 per share in 2009, and has grown its payout steadily to $1.44 in 2012.  That equates to a greater than 15 percent growth rate in dividends over that time period.  Because of the combination of a stagnating share price and increasing dividends, the stock now yields 4 percent at a stock price of $36 per share. 

However, no company can continue to raise its dividend forever at such a high rate if sales continue to decline.  Investors would be wise to monitor Hasbro’s sales performance in the near future and be ready to buy should the company find a way to return to sales growth.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Hasbro and Mattel, Inc.. The Motley Fool owns shares of Hasbro and Mattel, Inc.. 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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