In September 2017, the retail world was shaken by one of its biggest bankruptcies yet when struggling toy-retailer Toys “r” Us, Inc. filed for Chapter 11 bankruptcy.
The bankruptcy was a sign of two things: the Amazon.com, Inc. (NASDAQ:AMZN) takeover and waning toy demand. Toys R Us is simply struggling to compete at scale with the efficiency and convenience of Amazon. Meanwhile, the infusion of technology into the toy department has caused shoppers to opt for Best Buy Co Inc (NYSE:BBY) over Toys R Us. Kids these days are playing with smart tablets and video games, not Barbies and Hot Wheels.
Nonetheless, after going into Chapter 11, Toys R Us secured a $3.1 billion loan to keep its stores open. But holiday sales at Toys R Us were dismal. And profits looked even worse.
Now, no one wants to touch Toys R Us with a nine-foot pole.
As a result, Toys R Us is making preparations to liquidate all of its U.S. stores.
The Toys R Us bankruptcy and liquidation may just be the beginning of the headache for toy stocks. Traditional toy demand is waning, and technology companies like Amazon are making their own digital alternatives to Barbies and Hot Wheels.
Overall, the outlook for toy stocks is quite dour going forward. Here’s a list of 3 toy stocks that should be far from your buy list.
Toy Stocks You Shouldn’t Play With #1: Hasbro, Inc. (HAS)
Of all toy stocks, Hasbro, Inc. (NASDAQ:HAS) is the best positioned to weather near-term volatility.
Peer toy companies are planning to narrow their focus amid recent turbulence in the toy market, meaning Hasbro should benefit from less competition. Hasbro also has a big partnership with Walt Disney Co (NYSE:DIS). That gives it ownership over toys with secular appeal like Disney princess, certain Marvel action figures, and Star Wars toys. Hasbro is also teaming up with Netflix, Inc. (NASDAQ:NFLX) to make toys based on Netflix original characters, and any partnership with red-hot Netflix is a material positive.
Even with all those positives, I still wouldn’t touch HAS stock at these levels.
Revenues dropped 2% in the holiday quarter. That doesn’t seem all that bad. But there were major catalysts in the quarter, including a Star Wars movie and a Thor movie — plus a Guardians of the Galaxy movie and a Spider Man movie earlier in 2017. All those catalysts should have resulted in massive numbers in the holiday quarter. Plus, holiday spending hit a multi-year high in 2017, and even hugely struggling retailers like GameStop Corp. (NYSE:GME) reported revenue growth in the holiday quarter.
In context, then, Hasbro’s 2% revenue drop in the holiday quarter is really bad. Now, the company has to deal with a bunch of lost revenue from Toys R Us store closures and heavier-than-ever competition from Amazon and other tech giants.
Meanwhile, HAS stock has been beaten up, but its still not that cheap. You’re talking about a stock that is trading at 16.8-times forward earnings for roughly 10% earnings growth expectations. That gives the stock a price-to-earnings/growth (PEG) ratio of nearly 1.7, far higher than the market’s 1.1 PEG ratio.
All in all, this is a not-that-cheap stock which should be dirt cheap considering the company’s massive competitive headwinds.
Toy Stocks You Shouldn’t Play With #2: Mattel, Inc. (MAT)
Toy maker Mattel, Inc. (NASDAQ:MAT) is a little bit different than Hasbro. And not for the better.
Although the two companies are facing the same competition and Toys R Us liquidation headwinds, Mattel’s operations look a lot worse. And the stock isn’t that much cheaper.
So if you’re avoiding HAS stock, you should most certainly avoid MAT stock, too.
Mattel doesn’t have any of the same tailwinds that are propping up Hasbro. The company doesn’t have a big partnership with Disney. Nor any partnership with Netflix. Mattel is the toy company which is narrowing its focus amid recent toy market turbulence. And Toys R Us accounts for around 15-20% of Mattel’s U.S. sales, versus 14% for Hasbro.
The numbers illustrate this weakness in Mattel’s business. While Hasbro’s revenues declined 2% in the holiday quarter, Mattel’s revenues dropped 12%.
Things won’t get easier going forward. The company’s staple brands are in free fall. The Toys R Us liquidation will massively dent sales. And competition will only grow from tech giants.
Meanwhile, MAT stock is trading at a massive premium to its historical average valuation.
A big valuation against the backdrop of significant and persistent operational weakness is a recipe for disaster for MAT stock.
Toy Stocks You Shouldn’t Play With #3: JAKKS Pacific (JAKK)
Of all the troubled toy stocks, the one I’d avoid most is JAKKS Pacific, Inc. (NASDAQ:JAKK).
It tough to find a silver lining for JAKK stock amid all the recent turbulence in the toy market. The company was already struggling prior to the Toys R Us bankruptcy. Through the first 9 months of 2017, sales were down 12% and gross margins had compressed by more than 500 basis points.
The Toys R Us bankruptcy, though, accelerated the company’s operational deterioration. Holiday sales dropped nearly 20% year-over-year, while gross margins fell by more than 900 basis points.
Unfortunately, this is the new norm for JAKKS. Roughly 10% of the company’s sales in 2016 came from Toys R Us, and with U.S. store closings coming en masse, JAKKS stands to lose roughly 10% of its revenue. Meanwhile, margin headwinds remain in the form of competition from tech toys from Amazon and others. Plus, the balance sheet is loaded with debt.
Despite all these headwinds, JAKK stock still trades at over 30-times 2018 earnings estimates. That doesn’t make much sense. The market is trading at just 17-times forward earnings.
All in all, there is no reason to own JAKK stock here. Headwinds are only increasing in intensity, while the stock remains pretty richly valued considering its levered balance sheet and deteriorating growth prospects.
As of this writing, Luke Lango was long AMZN, BBY, and GME.