Mattel's Cost Controls Deliver Savings
By prioritizing inventory cleanup, the narrow-moat toymaker likely won't realize the full gains from its turnaround program as soon as originally expected.
Narrow-moat Mattel (MAT) continues its quest to squeeze $650 million in costs (15% of sales) out of its business over the next two years. We believe the turnaround is under way, but it could extend beyond the anticipated timeline, particularly as Mattel’s near-term priority remains on cleaning up pockets of global inventory. We view this as a riskier undertaking in light of more tempered end-user demand. However, we’ve incorporated reduced inventory initiatives over the next year (with inventory down another 8%) and gains from the turnaround program (at $150 million lower than the $650 million goal) through 2019, restoring operating margins to 15% in 2024 (lower than the 18% peak margin in 2012-13). While easy gross margin gains should come in 2018 from less inventory obsolescence, we expect many of the other initiatives (IT, process simplification) are unlikely to surface until 2019.
Further, we see two uncertainties that could lead to some variance in Mattel’s performance over time. First, Mattel is reviewing the return on investment from manufacturing product internally; if it opted to outsource this production (like narrow-moat Hasbro), this could free up significant capital to reinvest to protect the brand intangible asset that underlies our narrow moat, which we would view favorably. Additionally, while a bit late to the content game, Mattel now intends to co-produce content, following Hasbro’s pursuit, altering the business economics depending on the project. The latter uncertainties remain longer-term in nature but could favorably alter the cash flow profile of the firm.
After accounting for each of these facets, as well as increased spend behind product development--raising terminal S&A to 23.3% from 22% of sales--as Mattel invests to support its brand intangible asset, we’ve adjusted our fair value estimate to $22.50 (down from $25.50). However, we still view shares as undervalued, trading at a 26% discount to our revised fair value estimate.
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Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.