Hasbro Vs. Mattel: Which Is Better Prepared? – Seeking Alpha
Toys R Us (TOY) Bankruptcy
Chapter 11 bankruptcy is deemed a court-protected reorganization in simple terms. The company will be allowed to restructure its debt and other liabilities through negotiations with creditors, but only as long as the outcomes of those negotiations is approved by the court.
This may mean that toy manufacturers, having extended credit terms to the company for purchases, could take a one-time hit to revenue and earnings at some point. Most such companies will already be in the process of accruing the potential write down of receivables for months before the expense occurs in anticipation of the negotiated outcome. When it does happen it should not be a major issue for those toy manufacturers that maintain a strong balance sheet.
It may be that there will be limits to how much credit companies are willing to extend TOY credit on future purchases. That could make stocking up for the holiday season more difficult for TOY this year. It could also negatively impact the bottom lines of toy manufacturers.
This is just another step in the process of retail evolution and the need for toy manufacturers (as well as other consumer goods companies) to move more sales efforts online either directly to consumers or through intermediaries such as Amazon (AMZN), Wal-Mart (WMT), Target (TGT) and others. It will affect how toy makers advertise and it will also affect the bottom line.
“Toys R Us is just one of more than 300 retailers to file for bankruptcy this year, as Americans ditch the shopping mall in favor of their laptops, smartphones and tablets.” Quote from article in Washington Post
Both Hasbro (HAS) and Mattel (MAT) sell direct to consumers online already. The big question will be which one will be able to do it right and grow that side of its business. The other question is which of the two can build and maintain the strongest position the digital games world. The bankruptcy of TOY is just prologue to the greater revolution in the industry.
This is when the quality of management becomes paramount to future success. Efficient capital allocation, great vision and excellent execution will define the winners. The words in annual reports and press releases by every company will always paint a great picture of the future. The reality is that those are only words unless management has established a track record of consistent achievement. That is why the past remains important. It tells us whether management can deliver on its promises or if the vision it espouses is just words. I prefer to look for consistent execution over promises.
Mattel by the numbers
So, now we will take a look at how each company has performed over the last ten years to get a sense of the quality of strategy and management. Those things may change but culture is much harder to transform and without adjusting the culture progress is difficult. All of the following charts below were created by Mark Bern, CFA using data from oldschoolvalue.com. I will not attempt to explain the trends as that become a task of subjective futility and does not add much more to the picture. It is the trend itself that matters because it tells us how management has (and is) performing.
The revenue trend followed the general improvements in the economy from the depths of the financial crisis bottom in 2009 but peaked in 2013 and has been in decline since. This is obviously not a healthy trend.
Earnings have taken a similar path but with the decline more severe. It is no surprise that the price of MAT stock has tumbled by 67% since the end of 2013.
The dividend rose nicely as long as the company was growing but has flat lined since 2014. As we will see later in the side-by-side comparison the current yield is high but the dividend may be in jeopardy of a future cut.
FCF (free cash flow) is the life blood of a company. How it is allocated by management determines future prospects for growth and underlying health. MAT management has maintained the dividend and share buyback program while the company has not generated enough cash to fund those actions. This would appear to be merely an attempted exercise in propping up the share price which has failed miserably.
Since 2012, the company has used added debt to make up the shortfall and fund its decisions. This may not be sustainable over the long term.
The amount of debt held by MAT is not the problem. Even the trend would not be a problem if the company were growing. But when revenue and earnings are falling and debt is rising the result is unlikely to be good.
The trend in decreasing shares outstanding has ended out of necessity. I would be surprised if management attempted to continue the buyback program until the company can return to growth.
Acquisitions helped to fuel the growth in the past, but has not added needed growth since the last major acquisition in 2014. Where will the money come from to fund future growth? That is the question. I am not sure that management knows the answer either. Innovation would seem to be a promising route but it does not seem to the focus here.
Hasbro by the numbers
The trend has not been stellar in terms of revenue growth over the last decade but at least the company has held its own. The more recent trend since 2013 is encouraging, though.
This looks like almost a mirror image of the same chart for MAT; earnings increasing in 2009 and falling into 2013, then rebounding and growing strongly since. I like this trend and so do investors as the stock price has risen 74% since the end of 2013, justifiably so.
The dividend growth has been relatively consistent but slowing somewhat in the past three years, albeit still rising at a healthy clip.
Notice that the blue bars (representing FCF) have exceeded the orange bars (dividend and buybacks) in six of the ten years. Overall, the total of dividends and buybacks is more than FCF, but at least there is more balance than we saw from MAT where FCF was higher only twice. It is not a perfect picture but much closer to what I would expect from a successful business.
HAS management appears to use debt more sparingly than MAT, a good sign of more efficient asset allocation.
While the two companies are roughly the same size (as measured by revenue) HAS has only about half as much total debt on its books. This is not a trend, per se, but it does give me the sense that HAS management is better at allocating capital and keeping its capital structure healthy. That allows management more flexibility for the future to invest in growth when opportunities arise.
What I like about this chart is that management allocated a lot more toward buybacks when the stock price was much lower and represented a good value. Since the share price has risen management has tended to allocate much less toward buybacks. A well-managed company does not need to prop up its shares with buybacks. It consistently allocates capital to where the best return on investment is available. That appears to be what HAS has done.
The company has not used acquisitions to fuel growth in recent years as management apparently has determined that assets available to be acquired have been too expensive. Instead it seems to have sold off assets that were not generating adequate FCF to justify retention, selling into the high valuation environment.
Side-by-side Comparison (growth rates over ten years)
Now we will take a look at the two companies using a few ratios that I prefer to consider when assessing the health of companies.
The above table paints a very divergent picture between the two companies; one still on the rise, the other in decline. Both companies share prices suffered corrections since rumors about a possible TOY bankruptcy began, but HAS is off by far less (from its 52-week high) than MAT. I would expect this divergence to continue.
While MAT ten-year growth rates of everything but the dividend have been negative, HAS has posted positive compounded annual growth rates over the same period. Even though, the dividend yield for MAT is higher it is primarily the result of a falling stock price, not very enticing in my opinion, and probably not sustainable unless FCF improves significantly going forward. The payout ratio for HAS is a healthy, but sustainable level. The opposite is true of MAT. I would not be surprised if MAT were to make the difficult decision of cutting its dividend to conserve cash. It may need to if debt becomes too expensive.
From a valuation perspective, HAS appears to be cheaper but neither is what I could call a bargain with P/E ratios above 20. Obviously, HAS is the better value of the two but adding at this level may be more than my conservative approach can muster.
Debt for both companies is higher than I would prefer but, here again, there is a divergence as HAS debt can is at a manageable level while MAT is too high and likely to continue to rise as long as it is able to borrow.
If we were to look only at the Price to Sales or Price to Book ratios, one might surmise that MAT offered a better value. I would call this more of a value trap. Value investors may want to gamble on MAT being able to restructure the company and perform a turn around. But when I look at the next ratio, Price to FCF, the hairs on the back of my neck rise up. HAS has a reasonable Price/FCF ratio of 18 (we consider under 15 a bargain; see legend in the next section) while MAT is hugely negative. That one is an eye opener and should scare off any intelligent investors. It won’t scare them all off, of course, but that is what makes up a market.
HAS has a healthy cash position; MAT not so much. One has cash the other needs it.
Friedrich algorithm data file assessments
Now I want to take a quick look at how the Friedrich algorithm scores each company.
Source: Friedrich Global Research
Friedrich liked MAT in 2010 but flashed a warning in 2014 when FCF and revenue began to decline. It has been downhill ever since.
Source: Friedrich Global Research
HAS, on the other hand, received only one warning from Friedrich (2013) and consistently considered the company to be undervalued from 2014 through 2016. We added a position in HAS to our growth model portfolio (for subscribers) in December 2016 when the FROIC (FCF return on invested capital) rose above 20%. The legend below explains what we at Friedrich Global Research consider to be excellent, good, average and bad readings for each ratio used in our data files for each company shown above. The colors at the top of each column are also the colors used in the data file to help investors determine the general quality of a company at a glance.
The stocks of both companies have fallen since July when the first hints of a bankruptcy at TOY arose. MAT stock price has fallen 28% while HAS stock is down nearly 17% since. If this represents an opportunity may be questionable (based upon valuations) but if investors are considering buying either one this is certainly a better time to enter than last June. Were I considering a purchase at this time it would have to be Hasbro.
We hold HAS stock in our model portfolio, purchased on December 8, 2016, and intend to hold for the long term. That 2.4% dividend yield will help to ease any temporary pain.
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Disclosure: I am/we are long HAS.
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.
Additional disclosure: DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.