Mattel Has A Serious Inventory/Receivable Issue: 2017 Guidance Looks Unachievable – Seeking Alpha

Thesis: Despite weak sales over the past two quarters (caused by soft industry demand and elevated channel inventory), Mattel (NASDAQ:MAT) has guided for a significant rebound in sales that seems quite unachievable. Given significant levels of accounts receivable (a proxy for channel inventory) and balance sheet inventory, consensus expectations for 2017 revenue growth appear optimistic.

Weak Results Over The Past Two Quarters

Weak holiday sales: In late January, Mattel, Inc. reported weak Q4 2016 results. Sales declined 8.3% y/y to $1.83 million, 7.6% below the average consensus estimate of $1.98 billion. Mattel also reported EPS of $0.52, significantly worse than the expectation of $0.71.

In its Q4 2016 earnings release, Mattel said results were impacted by a number of industry-wide challenges, including a significant U.S. toy category slowdown for the holiday period and increased FX headwinds.

Despite the lackluster holiday results, Mattel said it was “broadly optimistic” about performance for 2017.

“Our results were negatively impacted by a number of industry-wide challenges, including a significant U.S. toy category slowdown in the holiday period, and increased forex headwinds… Even against this difficult backdrop, our core brands continued to show solid growth, and our performance in key emerging markets like China was equally strong. And, importantly, we offset a substantial revenue gap from the loss of the Disney Princess license. Looking forward, we remain broadly optimistic about Mattel’s performance in 2017 and beyond.” (Chairman and CEO Christopher Sinclair – Q4 2016 earnings results release)

Results continued to be weak for the spring season: Following the extremely weak 2016 holiday season, Mattel reported weaker-than-expected sales and EPS for Q1 2017.

Q1 2017 sales declined 15.4% y/y to $735.6 million (against a $797.6 million consensus estimate). In addition, MAT also reported a loss of $0.32, $0.15 worse than the average estimate of $0.17.

Mattel attributed significantly lower than consensus results to retail inventory overhang coming out of the holiday season.

“Our Q1 results were below our expectations due to the retail inventory overhang coming out of the holiday period, but we remain encouraged by strong performance at retail for our key core brands, including Barbie, Hot Wheels and Fisher-Price as well as sustained momentum in high-growth markets like China.” (CEO Margo Georgiadis – Q1 2017 earnings release).

Working capital deterioration may cause issues throughout the rest of 2017: With the backdrop of weak sales, MAT’s working capital trends are even worse. Inventory and accounts receivable levels are both at multi-year highs.

These trends are particularly concerning given that Mattel’s primary competitor, Hasbro (NASDAQ:HAS), has shown no signs of elevated inventory and accounts receivable levels.

As a result, it will be very difficult for Mattel to meet its 2017 guidance (more on this later). Let’s do a quick run-through of Mattel’s working capital trends first.

Surge in DSO/Receivables is evidence that channel inventory is FULL: In Q1 2017, accounts receivable increased 7.9% y/y to $806.8 million, and DSO increased 18.7% to 118 days (from a base period that increased 13.2%). In fact, DSO increased in each of the last five periods!

Source: 10-Q/10-K

Accounts receivable is often a good proxy for the amount of channel inventory (i.e. inventory at retailers before they are ultimately sold to consumers).

On its Q1 2017 Conference Call (CC), Mattel said it experienced sales and gross margin pressure as a result of retail overhang in the channel (following weak holiday sales, which slowed the pace of re-orders).

The company said the retail inventory overhang was primarily in the North America and Europe part of the business.

Further, Mattel indicated “most” of the inventory issue is behind it and that sales should reflect the underlying momentum of the business beginning in the second quarter.

Despite commentary that retail inventory levels are “behind it”, accounts receivable levels are still very high (in fact, at multi-year levels).

There appears to be a disconnect between what is going on with the balance sheet and what Mattel has told investors.

“When you look at our sales by region, you can clearly see that the retail inventory overhang was essentially isolated to North America and Europe. Asia-Pacific and Latin America saw minimal impact, with Asia-Pacific sales up significantly. And now that most of the inventory issue is behind us, we should begin to see sales reflect the real underlying momentum of the business as we pivot to the second quarter and build towards a strong second half.” (Richard Dickson – President and COO. Q1 2017 CC)

When questioned about accounts receivable levels, on the Q1 2017 CC, Mattel said receivables increased due to:

  • Country mix
  • Customer mix, and
  • “Later sales in the quarter”

“Yes, I think that’s a factor of country risk and - or country mix and also customer mix in different markets, as well as we saw later sales in the quarter. Those are the 3 drivers of the increase in accounts receivable.” (Kevin M. Farr-CFO. Q1 2017 CC)

Let’s go over the company’s excuses. Country mix likely did not have a big impact. Mattel specifically mentioned Russia and China where trade terms are “different and longer.” Russia is likely a very small portion of sales.

In its FY 2016 10-K, Mattel disclosed it barely hedges any of its Ruble currency exposure. In addition, Asia-Pacific sales only accounted for 11% of sales in the quarter.

What’s more interesting is that Mattel said sales occurred LATER during the quarter.

It is likely Mattel stuffed the channel with inventory by shipping a bunch of product to retailers (and didn’t have time to collect on them and thus the big receivables build). The only problem is it is basically stealing sales from future quarters.

Until the retail channel clears up, MAT will have difficulty reporting decent numbers.

HUGE inventory surge: In addition to potentially high levels of channel inventory, Mattel’s balance sheet inventory is also VERY elevated.

In Q1 2017, inventory increased 10.2% y/y to $769.8 million, and DSI increased 12.0% to 136 days. In fact, inventory and DSI both increased in each of the last seven quarters!

Source: 10-Q/10-K

Mattel attributed the increase in inventory to support new licensed entertainment launches and the continued positive key brand trends.

Further, the company said it was overall “comfortable” with inventory levels entering Q2.

One should always be cautious when companies talk up building inventory to support demand when the channel appears to be full.

If Mattel is unable to rationalize the substantial inventory build, margins will likely be compressed.

“And as expected, our owned inventory was up year-over-year, partially due to lower Q1 sales and to support our new licensed entertainment launches throughout the year and the continued positive core key brand POS trends we’re seeing on a global basis tracked internally at wholesale. Overall, we are comfortable with our inventory, both owned and at retail, as we enter the second quarter with later Easter and the June launch of Cars 3.” (Kevin M. Farr – CFO. Q1 2017 CC)

2017 sales guidance appears unachievable in light of working capital trends: On its Q1 2017 CC, Mattel guided for 2017 revenue growth in the mid-single digit range.

As of the date of writing, analysts expect sales to increase 8.2% in Q2 2017, increase 8.4% in Q3 17, and increase 9.4% in Q4 2017 as shown below:

Always be wary when companies (and analysts) expect a very lopsided second half of the year (especially with a huge surge in receivable and inventory levels).

Based on current sell-side estimates, Mattel is expected to generate 69.1% of sales in the second half of the year (Q3 and Q4), which is 250 bps above the three-year historical average.

The substantial back-end weighted year is particularly concerning given the accounts receivable and inventory trends discussed earlier.

Mattel has already experienced weak re-orders from retail partners due to elevated accounts receivable levels. On top of that, balance sheet inventory is also at multi-year highs.

This will make achieving 2017 sales guidance a difficult task.

By the way, this isn’t the first year in which Mattel provided full year guidance that it was ultimately unable to achieve.

Back in Q4 2015, Mattel guided for 2016 sales to increase in the low-to-mid single-digit range on a reported basis and remain flat on a constant currency basis.

In 2016, sales actually declined 4% on a reported basis and declined 2% on a constant currency basis.

Conclusion: With very clear evidence of elevated channel inventory and balance sheet inventory, it will be hard for Mattel to achieve its full year sales guidance.

As a result, Mattel is a short.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in MAT over the next 72 hours.

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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