Play is Getting Cheaper

By Nikhil Shamapant - February 19, 2012 | Tickers: HAS, JAKK, MAT | 0 Comments

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Hasbro (NASDAQ: HAS) is looks pretty cheap right now according to general press and snapshot valuations, supporting a dividend yield of 4% and a P/E of 12.7. Of course, when a dividend aristocrat gets cheap, it’s always a good idea to take a look and see if there’s value being thrown away, because with dividend aristocrats, there's a good chance there is. These are companies that have proved themselves over and over again as having something that no other company has through their ability to pay out and grow their dividends.

So lets take a look...

Hasbro is first and foremost a PLAY oriented company. Their goal is to use their current brand portfolios in the best way possible to maximize their yield, and to create new toy brands along the way. They use anything from toys, board games, trading cards, and movies to spread milk their brand power, and this brand power is ultimately what gives Hasbro a fundamentally strong competitive advantage. Hasbro offers well known brand names such as Transformers, Nerf, G.I. Joe, and Cranium, brand names that create a barrier making it hard to compete with Hasbro.  Hasbro also owns a 50% interest in a television network, The Hub, that shows high quality children and family oriented programming that can be used to spread Hasbro brands in the United States. Of course, right now The Hub runs at a loss on Hasbro’s books, but it’s really hard to tell whether any toy revenue has been effected by The Hub, which may be making this investment worthwhile. The Hub is clearly a way for Hasbro to enter the ‘digital’ age, and I’m not quite sure that its working.

Here's a quick overview of its general valuation:

Hasbro is liquid, but it clearly isn’t as cheap as it appears to be, its ratios only slightly below the industry averages. Given Hasbro’s relatively aged brands and its unproven ability to adapt to the change to the digital age of toys, it may only deserve a lower relative valuation. After looking at this thesis,that age lower Hasbro's valuation, I looked at the Hasbro's brands.. and I was shocked by their prevalance in society. Hasbro has control over modern brands such as Transformers, G.I. Joe, and SuperSoaker Waterguns as well as old classics like Monopoly, Battleship, and Connect Four(all of which I have in a shelf at my house this instant).

Compare them to Mattel’s (NASDAQ: MAT) brands: Barbie, Hotwheels, Cars, Batman, Dora, Thomas and Friends,  and American Girl. Mattel has fewer brands than Hasbro, but they seem stronger and more relevant than Hasbro's old classics, largely because they are for younger kids(in my opinion at least, of course it's really hard to compare these brands head on). I think older brands like Transformers and G.I. Joe are more 'on and off' brands, with demand much more based on the whims of children, whereas kids brands tend to be more stable, a two year old will never complain if watching Dora for example. Even so, Mattel's relevance doesn't detract from the fact that Hasbro controls a lot of market share, and is definitely a force to be reckoned with in the toy world. So what are the risks of Hasbro’s business? Cheap valuations are often value traps and you want to make sure to avoid that kind of situation before investment.

1. Low Barrier to Entry Industry

Yes, Hasbro has their brand barrier, but brands are hit or miss and subject to the whims of popular culture. It really isn’t hard to ENTER the industry. Staying in the industry once your product has been milked of course, is a totally different story, but this is a big risk to Hasbro’s business, competition is easily created and can only be destroyed by the population’s random choice.

2.-“During 2010, net revenues from our three largest customers, Wal-Mart Stores, Inc., Target Corporation and Toys “R” Us, Inc., represented 23%, 12% and 11%, respectively, of consolidated net revenues, and sales to our top five customers,including Wal-Mart, Target and Toys “R” Us, Inc., accounted for approximately 50% of our consolidated net revenues. In the U.S. and Canada segment, approximately 71% of our net revenues were derived from these top three customers.”  --This is probably more because of the 3 stores’ retail power than because of Hasbro’s reliance upon their demand, but its good to keep an eye on the fact that Hasbro is so reliant on three main customers. Given that they are all blue chip retailers, it’s unlikely that anything will actually come of it.

3. Perhaps the biggest risk: The problem Hasbro management refers to as ‘children getting older younger’

From the 2010 Annual Report: In addition to contending with competition from other toy and game and branded play entertainment companies, in our business we must deal with the phenomenon that many children have been moving away from traditional toys and games at a younger age and the array of products and entertainment offerings competing for the attention of children has expanded. We refer to this as “children getting older younger.” As a result, our products not only compete with the offerings of other toy and game manufacturers, but we must compete, particularly in meeting the demands of older children, with the entertainment offerings of many other companies, such as makers of video games and consumer electronic products.”

This is a major issue for Hasbro, and while its great that management has recognized the problem and is fighting back, it doesn’t make the problem any easier to solve. Any investment in Hasbro has got to reflect a belief that Hasbro will be successful in attempts to change from its prior dividend aristocrat business to a more risky digital content based business. Of course, they are benefitted by ability to simply move their physical brands to digital content, but there is a lot more competition in a digital market than in the already low barrier toy industry they had already been in.

Finally, what’s Hasbro actually worth? Price determines return, so it’s a must to look at Hasbro’s intrinsic value and compare it to intrinsic values for the industry(industry being these three companies as they are most often brought up in the same context). These valuations are based on my personal discounted cash flow calculations.

Clearly,  Hasbro and Mattel seem fairly well valued according to my assumptions (modest industry growth). It’s unlikely that Hasbro will surprise us with above expected growth in the next 10 years, and I think its brands will bring modest enough growth to merit this valuation; However, at these prices it seems that neither Mattel nor Hasbro makes a great investment.

Jakks Pacific, on the other hand, may merit some more research.

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