Mattel, Activision More Undervalued Than Wall Street Darling Apple

By David Gould - September 4, 2012 | Tickers: ATVI, AAPL, MAT, MSFT, DIS | 0 Comments

• Email
• Print

While Black Friday may be some time off and the economy still a little bit (to say the least) uncertain, consumer goods still have a lot to offer. Mattel (NASDAQ: MAT) is paying a 3.5% dividend yield at a reasonable price. Activision Blizzard (NASDAQ: ATVI) has phenomenal growth and opportunities ahead. And Apple (NASDAQ: AAPL) keeps churning out impressive free cash flow. In my view, Apple is not as undervalued as Mattel or Activision. Below, I review the fundamentals of each company.

Mattel

Mattel trades at a respective 15.8x and 13x past and forward earnings with a dividend yield of 3.5% and a beta of 0.9. During the second quarter, management beat expectations by a terrific 33.3% with EPS of $0.28. More importantly, the company is on a positive growth trajectory from EPS of $1.03 in 2002 to $2.18 in 2011.

In 1H12, solid progress was experienced across core brands and markets. FX headwinds are being offset by volume expansion in countries such as Brazil, China, Mexico, the U.K., and India. In fact, two-thirds of the company's business comes abroad, and most of the categories have outperformed peers'. Market share has correspondingly risen in infant/preschool dolls and vehicles.

Solid momentum has been seen across Barbie, Hot Wheels and American Girl. New Disney (NYSE: DIS) titles have also increased demand in toys for Brave, Disney Princess, Jake, and Batman, among others. Barbie has become increasingly popular domestically and in the Euro 5. Beyond the current product line, Mattel has attractive opportunities going forward. Costs can easily be cut as management works hard on reducing exposure to volatile commodities, currency, and labor while optimizing geographical sales mix.

Activision Blizzard

Activision is more expensive than Mattel on a past earnings basis but cheaper than Mattel on a forward earnings basis. Only one thing can explain this: analysts forecast stronger growth for the game producer. Activision achieved 20.6% annual EPS growth over the past 5 years but is forecasted to achieve just 10.6% annual EPS growth over the next 5 years. In my view, this sets the bar fairly low for high risk-adjusted returns. Analysts already rate the stock a 1.8 out of 5 where 1 is a "buy", so the margin of safety is, in any event, fairly strong.

Perhaps more importantly, Activision is a free cash flow machine. CAPEX is very low and has not commensurately increased with rising volume. As cash flow rose from $370M to $1.4B from 2008 to 2010, CAPEX only rose from $46M to $97M. Improving margins enables the company to maximize the benefits of expansion.

Fundamentally, Activision is increasingly looking like a leader in the video game business. Just when many investors thought it was "World of Warcraft or bust", Activision showcased that it could just create new iconic titles. For 1H12, Activision launched the 3 best-selling video games in Europe and North America: Skylanders, Modern Warfare 3, and Diablo III. That's an incredible feat given the intense competition from Nintendo's Legend of Zelda: Skyward Sword, among others. Management is focused on increasing global reach for its Call of Duty series, which will of course create meaningful cross-selling opportunities in and of itself.

Apple

What is there not to say about Apple? From the iTouch to the iPhone to the iPad, the consumer tech company has excited the market time and time again. Currently, many commentators are wildly - and I mean, wildly - speculating about Apple TV. It sounds like a bit of a cult; don't worry - because it is a bit of a cult.

The problem that I see with Apple is twofold: First, it is coming under pressure from "the law of big numbers". At a $624B valuation, Apple is not only the most valuable public company in history, but is also worth roughly 2.5x peer Microsoft (NASDAQ: MSFT). If that is your kind of value play then please go ahead and buy. But for an industry with little to no barriers to entry and intense competition, Apple really doesn't have a sustainable competitive advantage. Sure, its brand is very powerful, but many investors and consumers would have said the same thing about Microsoft or… dare I say… Research in Motion some years ago.

Second, as it stands, Apple does need plenty of growth to justify its current valuation. Even if it becomes the first trillion dollar company by 2016, I find that these two attractive stocks are still more undervalued. According to FINVIZ.com, analysts are forecasting annual EPS growth of 21.1% over the next 5 years. In my view, this is simply too much for a company that has not fully extended itself through a diversity of mediums. While mobile has helped extend the brand, it remains by and large a "toy" company, if you will. Microsoft, on the other hand, has a business in search, software, and PCs, developments in mobile, investments in social networking, video, and so forth. Apple may have a large economic moat, but its job over these next few years will be to expand cross-selling opportunities that go beyond just leveraging the brand name. Success in that endeavor is highly uncertain and, in my view, warrants preferential buying of Activision and Mattel.

• Email
• Print
• Feedback