Hasbro: Highest Earnings Quarter – So What? – Seeking Alpha

Plunge Post-Earnings Announcement

In early September, as the news of Toys “R” Us filing for bankruptcy broke, I wrote an article discussing the implications of the development on Hasbro (HAS) and Mattel (MAT). In it, I said:

“… the charts suggest that technically the share price of Hasbro could still weaken further. Based on the multi-year price channel, the share price of Hasbro could touch the bottom of the channel at ~$89-90 before rebounding. It could turn really ugly if the shares breach the support line convincingly.”

Nevertheless, after having done my due diligence, I decided at the $93 level, it was already good value and entered my first position into the counter. I have shared my thoughts in the article titled Hasbro: Value has emerged. I reckoned then that it would not be wise to wait for a $3 drop (to $90 – bottom of channel) which might not happen but possibly miss out on a potential $25 gain (if I missed the proverbial boat and the share price subsequently hit the upper channel at ~$118). Alas, the share price indeed touched the bottom of the channel at $89 yesterday before rebounding. While there is the opportunity cost in being two months early, in addition to the higher price paid, I did not regret the purchase as I was comfortable with the entry price. I am consoled by the fact that even Warren Buffett is known not to be able to “catch the bottom“.

Hasbro Price Chart 2017 Oct 24

3Q 2017 – Highest Revenue And Earnings Ever

A casual observer in Hasbro would never have thought that in the latest reported quarter, Hasbro achieved its highest revenue and earnings in its history. That was because the share price plunged 8% post-results. Net revenues for the third quarter 2017 rose 7% year-on-year to $1.79 billion. Net earnings increased 3% to $265.6 million, or $2.09 per diluted share, compared to $257.8 million, or $2.03 per diluted share, in 3Q 2016.

Despite challenges on the business front, Hasbro managed to end the quarter with $1.2 billion in cash, even after returning $164 million to shareholders through its dividend and repurchase program. Considering that historically, the 3Q of each year required the greatest increase in working capital due to the Christmas orders season, it is obvious that Hasbro can look forward to higher Free Cash Flow in the next (and final) quarter of the year. Correspondingly, the net total long-term debt should see a continued reduction and possibly even turn negative (net cash position). The remaining debt has also become less burdensome as the company managed to refinance $350 million of maturing debt at an interest rate of 6.3% by issuing $500 million of new 10-year debt at a low 3.5% interest rate. With this move, Hasbro would be able to save approximately $4 million per year on interest expense.

ChartHAS Free Cash Flow (Quarterly) data by YCharts

Downward Revision In Guidance Strengthened The Bear Clutch

The trigger that sent the share price heading south, a reversal from the initial price appreciation post-results announcement, was the downward revision in revenue guidance. The management has forecasted that the fourth-quarter revenue would grow year-over-year in the range of 4% to 7%. This meant that the fourth quarter growth could potentially be lower than the year-to-date growth rate at 7%. Deb Thomas, chief financial officer at Hasbro, attributed the weaker guidance to “higher near-term uncertainty with Toys “R” Us” as the retailer work on emerging from Chapter 11. However, what the market participants probably missed or glossed over was the fact that the management suggested in the earnings call that the revised guidance was more of a prudent act rather than an outcome cast in stone (emphasis mine):

“… out of an abundance of caution, we did want to highlight that it’s a more fluid environment only because of the Toys “R” Us situation, and of course the U.K. and Brazil situation. But clearly the bulk of the difference in our point of view was about the Toys “R” Us situation. … we just give you a range because again as we formulated our look at the earnings picture as of today we felt that our range would be prudent.”

With the agreement with Toys “R” Us signed just a few days ago, the management is still evaluating the level of business it is prepared to give the retailer that would commensurate with the risk/reward from doing so. If Toys “R” Us performs better than expectations, it is possible that Hasbro could set itself up for another earnings beat.

The consensus price target was lowered, albeit just gradually, in the past months. As a result, the gap between the price target and the current price has widened considerably. Looking at the valuation derived from historical multiples, the gap has increased to as much as $32 ($124.20 – $92.22) based on the last available data.

ChartHAS data by YCharts

Bright Prospects

Hasbro has been outperforming its peers with industry-leading growth. Even for the fourth-quarter, the company still expects to better the industry’s 3 to 4% growth rate. Undue attention has been paid to one underperforming customer (Toys “R” Us) but Hasbro has achieved two to three times higher growth via the omnichannel and online retailing than its overall Point-Of-Sale (“POS”) gains. The Washington Post has a good write-up featuring the distinction between Toys “R” Us and the neighborhood toy stores which offer better customer service and better shopping experiences. The point is that there are many avenues where Hasbro can sell its merchandise. In any case, the bankruptcy at Toys “R” Us was more attributable to the crushing debt its private equity owners loaded it with than the notion that children and parents reduced their purchases from Toys “R” Us significantly. This is exemplified by the fact that the Asian operations of the toy retailer are unaffected by the “financial restructuring” of Toy “R” Us, Inc

In terms of the outlook of character-driven toys and collectibles, Brian Goldner, the chief executive officer, said it best in the earnings call:

“Yes, I believe that the entertainment lineup for 2018 is actually stronger than 2017. If you think about the opportunity that begins early in the year with Black Panther, an exciting new movie from Marvel Studios, we get into Avengers by May, we have a Han Solo: STAR WARS story movie in the end of May. We have our very own Bumblebee movie that comes in December next year, you’ve got Toy Story 4. You’ve Ant-Man and the Wasp, and then you have Spider-Man animated movie that comes at the end of the year as well, at the end of ’18.”

Hence, the healthy pipeline of movies from Marvel (DIS), Lucasfilm, and its in-house studio would strongly support the sale of related merchandise.

Conclusion

The share price of Hasbro plunged post-results. However, it does not mean that the long-term prospect of the company has diminished. There is a great dose of prudence in the 4Q 2017 guidance largely due to the uncertainty surrounding the creditworthiness of Toys “R” Us. Fundamentals are stronger than ever. Due to another commitment, I was not able to assess timely the 3Q 2017 results and determine my next entry point. Nevertheless, I now stand ready to redeploy the proceeds from the recent sale of my holdings in Crocs (CROX) to Hasbro should its share price drop to $89 again.

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Disclosure: I am/we are long HAS, DIS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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