Hasbro, Mattel Show Off New Products
After seeing their latest offerings, we're maintaining our outlook for both toy makers.
Toy Fair 2016 saw the launch of a load of new products from Mattel (MAT) and Hasbro (HAS), reassuring us that these companies' management teams have not lost focus on supporting brand equity, a key tenet underlying our narrow economic moat ratings. With both companies recently reporting year-end results, their outlook for financial performance in 2016 was unchanged and long-term guidance remained intact as well. At this time, we plan to maintain our $28 and $72 fair value estimates for Mattel and Hasbro, respectively.
The common theme this year across the major toy marketers is the continued focus on content to drive demand. Over the next two years, Hasbro will design toys for seven theatrical releases, including Marvel's Civil War, Spiderman, and Thor; Disney's Moana; Hasbro's own Transformers 5; and Star Wars Episode 8. Hasbro has exposure to a consistent content lineup through the end of the decade, which should help to reduce cash flow volatility relative to its prior movie cycles, when slow movie years hindered the ability of the business to increase the top line easily year in and year out.
Moreover, Hasbro Studios has articulated more than 1,500 half-hours of content for channels such as Discovery Family, supporting $1.6 billion in TV-backed merchandise sales since 2009, helping to bridge the storytelling gap on the company's brands. In our opinion, Hasbro has worked hard over the past five years to craft a business model that can competitively and tactically navigate the global economic environment. Our main concern is that the benefit from the consistent content cycle has largely been factored into the share price at current levels, rendering incremental upside surprises more difficult to capture.
2016 will incorporate the Disney Princess licensed revenue (quoted at $450 million from Mattel at gross). Star Wars is likely to be as meaningful in 2016 as 2015, which is not terribly surprising, given the Dec. 18 launch date in the United States and later in China. Also, gross margins should be sustainably higher in years ahead--just a few years ago, the targeted gross margin range was 58%-59%, and Hasbro is now targeting gross margins of roughly 62%. We aren't surprised by this sustainably higher level, as rising entertainment-related revenue generally offers higher gross margins at the expense of higher royalties, offset somewhat by lower advertising. However, we have already modeled this benefit into our outlook for Hasbro, which calls for gross margins just below 62%, operating margins that expand to nearly 18% over the next decade, and high-single-digit to low-double-digit earnings growth, depending on the year. Given this, the forward 2016 price/earnings multiple of 18 times looks a little expensive.
While parts of Mattel's presentation could have been interpreted as scripted, we thought it implied the team's level of preparation in light of the turnaround that is still underway. We don't believe it is yet time for the company to shoot from the hip in this type of forum, and we saw the presentation as management's attempt to craft a clear and specific message after spending the past year diligently working on improving many of its product lines (especially in the most recent fourth quarter, when shipments for Hot Wheels, Fisher-Price, Barbie, and Thomas were strong). Ultimately, brand equity is what supports expanding returns on invested capital at the enterprise; we project that ROICs will rise from a forecast 15% in 2015 to 20% by the end of the decade if Mattel manages to reignite sustainable top-line growth.
Mattel has admitted that it is not yet out of the woods and that 2016 will be part of the turnaround process. The financial outlook indicates that this will be a critical year that determines whether product improvement will truly begin to take hold or new offerings will fail to spark top-line growth in a meaningful way. The company reiterated its 2016 outlook for flat sales in constant currency, with gross margins around 50%, around 12% spending on advertising, and lower dollar spending on selling, general, and administrative expenses, paving the path back to operating margins of 15%-20%, which Mattel believes could come as early as 2017. Our forecast calls for a revenue decline of 2% (including foreign exchange movements) and operating margins of 12%, leaving Mattel still trailing Hasbro's 6.5% top-line growth and 15.9% operating margin estimates for 2016 by quite a bit. However, even factoring in high-single-digit normalized earnings growth for Mattel, which is trading at 22 times our forward 2016 estimate, implies to us that the turnaround is in the bag and such a premium is warranted. In our opinion, the proof will be in forward results, and a leap of faith would be required to invest at current valuations.
Nevertheless, the green shoots that could lead the way back to Mattel's target operating margins were evident, and we believe the company is putting forth its best efforts to jump onto the content-creation cycle from which Hasbro has benefited in recent years; this was sorely missing under prior leadership. The renewal of both the Toy Story and Cars licenses with Disney in the past few months, along with the Warner Bros. DC Comics relationship and recent acquisitions of Sproutling and Fuhu, indicates to us that management is focused on connecting with consumers in new and meaningful ways. The new touchpoints that Mattel captures should offer additional insight into the company's consumer base, leading ultimately to products that cater even better to current demand than before.
We didn't hear much from Mattel or Hasbro to alter our long-term top- and bottom-line assumptions, and we still believe Mattel has the better operating margin and cash flow expansion potential from current levels. We are cautious in the near term on Mattel, as the company is still in the process of reinvigorating many of its core brands, but we think our longer-term estimates could prove light if updates to brands like Thomas, Barbie, and Fisher-Price improve in a more sustainable way than in the past.
Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.