How to Play the Evolving Toy Story

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The toy industry in the United States is essentially a duopoly. Mattel (NASDAQ: MAT) and Hasbro (NASDAQ: HAS) are the two-headed beast that control the bulk of the industry.

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. Meanwhile, Mattel’s stable of great brands includes Barbie, Hot Wheels, and the Fisher-Price and American Girl brands.

For months, detractors of investing in either of the two toy giants pointed to the surge in popularity of gaming on mobile devices. The bear case may be making some traction, as Mattel’s recent earnings disappointed the market and its stock plunged.

Major rival Hasbro is set to report earnings next week, and the market isn’t overly optimistic. In light of all this, here’s how investors should trade the challenges facing the toy industry.

In need of a shake up

Mattel has a long and proud history, having held the Barbie brand for decades. At the same time, consumer preferences don’t stay static for long, and the Barbie line in particular now serves as a drag on the company’s bottom line.

All told, Mattel’s second-quarter net income dropped 25%, to $0.21 per share from $0.28 per share the year prior. This failed to meet Wall Street expectations of $0.32 per share. Moreover, although revenue inched up less than a percent, that figure again failed to meet analyst expectations.

As previously mentioned, weakness was concentrated in the company’s Barbie product line. Barbie sales fell 12% during the quarter. Mattel and Chief Executive Officer Bryan Stockton have known for some time that Barbie sales would lag, and as a result, the company has spent considerably to expand its other, more popular brands.

For example, Mattel’s American Girl brand posted 14% sales growth in the quarter, and that’s where the company’s focus will be going forward.

Strong companies with strong returns to shareholders

Despite the hiccups, Mattel and Hasbro shares have been on fire this year. Hasbro is up nearly 30% just since the start of 2013, and Mattel is up nearly 20% including its post-earnings sell-off.

Not only that, but these two companies provide their shareholders with solid dividends, in addition to the robust share price gains seen since the start of the year.

Hasbro raised its first-quarter dividend 11%, and has doubled its payout over the past five years. Mattel raised its own dividend by 16% in the first quarter and has also nearly doubled its dividend over the past five years.

Because of their strong dividend growth rates, each stock yields approximately 3.33% at recent prices. These yields compare very favorably to the yield on the broader market. In comparison, the S&P 500 Index yields just 2% at recent prices.

Look for buying opportunity if sell-off continues

As of now, both Mattel and Hasbro trade roughly in-line with the broader market. The downtrend in sales at Mattel is concerning, but this is a cyclical industry and bumps in the road are to be expected.

The major challenge will be to see if the plans laid out by Mattel management prove beneficial. If sales recover in subsequent quarters, the recent sell-off will prove to be a major buying opportunity. Besides which, it’s worth noting that the summer is not nearly as critical to the toy makers as the crucial holiday season.

That’s when both Mattel and Hasbro derive the vast majority of annual sales, so building out a successful strategy ahead of the holiday shopping season may turn out to be a shrewd move.

As a result, I’d view any significant pullback in Hasbro and Mattel as solid buying opportunities, particularly if expectations regarding the holiday shopping season remain optimistic.

Robert Ciura 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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