The toy industry is not exactly in a dire situation, even though it may seem that way. After Toys “R” Us declared bankruptcy on March 15, Mattel, Inc. (NASDAQ:MAT) continued its decline. Previously, its stock held up on speculators hoping the company would merge with Hasbro, Inc. (NASDAQ:HAS). Since the toy industry is consolidating, that merger idea does not sound all that bad.
In February, rumors surfaced that Hasbro and Mattel did indeed want to merge, something that would make a lot of sense. Hasbro reported fourth-quarter sales that fell year-over-year. Mattel’s revenues missed consensus estimates by $80 million, falling 12 percent YOY to $1.61 billion. On its conference call, Mattel CEO Margo Georgiadis said the company was optimistic that its business would stabilize this year. Driven by cost reductions, improving profit trends and momentum for its goals set in June, strengths from Mattel’s fourth quarter could continue. It benefited from pockets of strength when Cars 3 met its revenue targets. Its partnership with Walt Disney Co (NYSE:DIS) resulted in strong international market strength.
Unfortunately, Mattel gave few tangible details explaining just how it would drive revenues. It spoke of zero-cost budgeting, revenue stabilization and management expectations but gave no further information. When an analyst asked where revenue would be this year — growing or declining — management said it would give more details at Toy Fair. Mattel clearly has inventory it has to work through and cost reductions it must implement before it expects any profit growth.
Unhappy News for Mattel Stock
The bankruptcy of 380 Toys “R” Us stores in North America is an unhappy development for the toy industry. The closure removes a sales channel for Mattel and Hasbro and could hurt near-term sales. Heavy, unmanageable debt hurt the once great toy store. As the company goes through the bankruptcy proceedings, Mattel stock will have few, if any, reasons to trend higher. The liquidation of the store’s assets and removing the supply stores will force the toy market to evolve.
Amazon.com, Inc. (NASDAQ:AMZN) will probably pick up much of the market share in toy sales. The online retailer has an efficiently designed e-commerce platform where it may easily add more toy product offerings online. Unlike Toys “R” Us betting the company by taking a $3.1 billion loan in September to keep open through the holidays, Amazon.com may add or remove toy products as demand patterns shift. If the online retailer charges too much for Mattel’s goods, consumers will just go elsewhere. Amazon.com may then adjust prices lower to compete with other retailers. So if Target Corporation (NYSE:TGT) or Walmart Inc. (NYSE:WMT) sold Mattel toys for less, Amazon.com must match those prices. The net beneficiary of the inefficiently run Toys “R” Us is effectively the toy suppliers like Mattel and Hasbro. Retailers will adjust prices and manage toy inventory according to demand. This equilibrium should result in Mattel reporting higher profitability in 2018.
Assume that revenue growth stabilizes to flat growth in the next two years and starts rising in the range of 2 percent to 5 percent. Using a 10-year DCF Revenue Exit model, and applying a revenue exit multiple of between one times and three times, Mattel stock is valued at over $15 a share.
Bottom line on Mattel Stock
Mattel stock valuations are not the most attractive, with a debt/equity of 2.5 times and a forward P/E of 24 times. But the stock is valued at less than one times sales. If the toymaker succeeds in cutting costs, lowering inventory and raising international sales, then Mattel stock will recover. With a weakly managed store out of the market, Mattel has a good chance of achieving just that.
Disclosure: The author does not own shares in any of the companies mentioned.