Hasbro: Re-Evaluating The Stock, Recent Takeaways After Earnings – Seeking Alpha

With the financial results released for the third quarter, and the decline in stock price, I look to re-evaluate my long position in Hasbro (NASDAQ: HAS), and provide my perspective and takeaways. Last month, I initiated a position in Hasbro on the previous pullback in stock price. At that time, the stock had already gone through a -20% decline, and in my opinion, the stock was trading at a discount to its fair value with reasonable upside. After re-evaluating investor concerns and the recent financial results, I still feel comfortable with my long position. I provide a brief overview of my takeaways from the financial results in the sections below.

(Source: FreeStockCharts)

High Expectations for Fourth Quarter and Toy “R” US Bankruptcy

Management’s updated guidance for fourth quarter results was the perceived cause of the current selloff for the stock, a decline of over 8%. The company otherwise had a solid third quarter, exceeding expectations for both revenue and earnings per share. The company’s revenue and earnings per share were $1.79 billion and $2.09, respectively, in comparison to analyst consensus estimates of $1.78 billion and $1.94, respectively.

The company is now expecting 4% to 7% revenue growth as opposed to expectations of 11.7% or $1.82 billion, currently reported by Reuters. I made note of the high fourth quarter expectations in a previous article when I first initiated a position, and was aware of the idea that the stock price could suffer slightly in the fourth quarter due to these expectations. The Toys “R” Us bankruptcy was also another short-term concern to consider that had the potential to impact the company’s bottom line in the next few quarters. These concerns, however, continue to be only short-term challenges, and I believe the company’s long-term growth and financial health will not be affected. As reported on Hasbro’s 10-K filing, Toys “R” Us accounted for 9% of Hasbro’s total revenue, thus the bankruptcy will cause disruption to the company’s supply chain. However, it is my belief that Hasbro just needs some time to figure things out, and supply the demand for its products through other retail or e-commerce channels — time that the company should have based on the fact that Toys “R” Us has obtained debt financing, and is working out agreements with Hasbro. As reported, the company is still providing inventory to Toys “R” Us, but assessing how much inventory to provide.

Per the company’s earnings call transcripts, management indicated:

Yes, so clearly we are assessing what Toys “R” Us can receive, but our expanded retail channel strategy gives us great confidence that we can find home for our inventories, and given where our inventories are and that they’re in great shape and that fact that POS is growing at double digits both globally as well as in the U.S.

Evaluating Lower Operating Profit

As reported, and further discussed by management in the earnings call transcripts, although revenue was up for the third quarter, the company experience a decline in operating profit.

(Source: Hasbro’s Third Quarter 2017 Earnings Slides)

Management cited bad debt expense associated with the Toys “R” Us bankruptcy as the main driver for the decline in operating profit. Per Management on the earnings call:

Hasbro operating profit dollars were essentially flat and operating margin declined to 20.1% versus 21.6% in 2016. As mentioned, operating profit margin would have been approximately 100 basis points higher, excluding the bad debt expense.

In reviewing the company’s statement of operations, we see that Selling, Distribution and Administration expense, which includes bad debt expense, has increased by 0.4% when compared to the same period last fiscal year. Also, cost of sales has increased by 1.6%.

In the earnings call, management addressed the increase in cost of sales, and confirmed its guidance given earlier in the year:

But if you move up to margin, gross margin and you think about the guidance that we’ve been giving all year is that we did say we expected our gross margin and our cost of sales actually to be higher than a year-ago, because of the mix of product and also some less favorable hedges that we had in place and it’s not that were not hedging.

(Source: Company’s Press Release – Financial Results)

Quantifying the Impact of Bad Debt Expense Associated with Toys “R” Us

As previously stated, management stated that operating margin would be approximately 100 basis points higher, when excluding bad debt expense. This would indicate operating margin to increase from 20.1% to approximately 21.1%, before bad debt expense. I provide further context of the impact to the bottom line below:

(Source: Company’s Press Release – Financial Results, with Author’s calculations)

Per the table above, an additional 1% of total revenue added to operating profit leads to an increase of about $13.6 million net of taxes, and about $0.11 to be added to earnings per share (diluted). With operating margin only slightly lower from the prior period last year, and the exclusion of the bad debt expense impact, I don’t believe operating profit is much of a concern.

Assessing Company’s Growth

Hasbro continues to show moderate to strong growth in its revenues.

(Source: Hasbro’s Third Quarter 2017 Earnings Slides)

As discussed in my previous article, the company’s international segment growth was a ongoing concern for investors. Per the slide above, international growth for the nine month period in 2017 is 5% as opposed to 12% for the same period in 2016. However, the 12% growth in 2016 should be taken into context. When excluding foreign currency translation from the international segment for the nine month period ending for 2015, 2016, and 2017, I calculated the following:

(Source: Company’s 10-Q Filings and Earnings Slides, with Author’s calculations)

Thus, negative foreign currency translation has a significant impact on net revenue for the company’s international segment in 2015. In turn, this skews growth comparisons year-over-year.

Concluding Remarks

In conclusion, Hasbro is facing short-term challenges associated with the bankruptcy of Toys “R” Us and with fourth quarter expectations coming in a bit too high; however, in my opinion, Hasbro remains financially healthy and is exhibiting moderate to strong growth. As previously discussed above, after adjusting for bad debt expense associated with the Toys “R” Us bankruptcy, the company’s operating profit is only slightly down from the same period last year. In addition, the company shows growth in its top line revenue, its Segments, and its Brands, with only a slight exception to a 2% decline in its Partner Brands. The international growth comparisons need to be taken into further context, as these have been skewed by a large negative foreign currency translation in 2015. From my perspective, the company is still in a good position to succeed, despite having a few “rough patches” along the way. Looking forward, and reported by TheStreet, Marvel is expected to release eight movies in 2018 which could serve as a future catalyst of growth for Hasbro. In addition, the company now has a 2.5% dividend yield and remains shareholder friendly with its stock buybacks. After evaluating the results, I continue to hold my long position and may consider adding to this position depending on how stock price shakes out.

As always, you should perform your own due diligence and evaluate your own portfolio and risk before initiating or selling a position in the stock mentioned. This article is written for informational and educational purposes only.

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