While the messaging surrounding Mattel’s (MAT) structural simplification plan and the monetization of its robust intellectual property hasn’t changed, the cadence of improvement appears to be slower than investors had hoped for, as the share price tumbled after the company’s recent analyst meeting. Mattel’s resurrection has been on a protracted path since 2017, and we don’t anticipate the pace to accelerate as the secularly slow-growing toy industry--where we see growth around 3% on average--remains a headwind to the successful execution of the cause.
Nearly every metric that Mattel offered regarding 2019 guidance was both disappointing and lighter than our prior forecast. First, while constant-currency sales are forecast to be flat, foreign exchange is anticipated to provide a 75-basis-point headwind at the midpoint, implying that Mattel is set for its sixth year of as-reported sales declines; this is below our projected 3% sales rise and marks sales at about two thirds of 2013 levels. Second, the gross margin outlook for the low 40s was short of our 45% estimate, hurt by input costs and currency. Finally, a slightly positive level of adjusted operating income is well below our $284 million estimate. At first glance, adjusting our projections more closely to align with Mattel’s updated guidance doesn’t materially alter our $21 fair value estimate. As we roll our model forward, a weak 2018 will be removed from our forecasting window and replaced by a lower loss in 2019, pushing improved cash flows through our discounted cash flow model. Despite the delayed improvement, we are holding the line on our long-term outlook for a 14% operating margin in 2023 with operating changes underway. We think the shares are undervalued, but we caution that the road to improvement could be rocky, warranting a longer time horizon.
Jaime M. Katz, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.