The early optimism surrounding the first-quarter earnings report from Mattel, Inc. (NASDAQ:MAT) dissipated quickly. On the morning of April 27, Mattel stock was up 9%. By afternoon trading, however, the gains in MAT stock were all but gone.
Less than two weeks later, MAT is up a paltry 2.3%.
That reaction looks about right. A strong performance on the top line in Q1 seemed to bode well for the long-running turnaround hopes at Mattel. But, in fact, revenue wasn’t quite as strong as headlines or a consensus beat suggested. And a significant earnings miss leaves the highly indebted company reliant on significant improvement in the second half of the year.
With Mattel stock near a post-crisis low, I can see the case for investors trying to buy a turnaround here. But there’s simply too much debt — and too much risk. From that standpoint, the quickly fading optimism that greeted the Q1 report makes quite a bit of sense. Any upside from Mattel is going to take a lot longer than one quarter to materialize.
Relative to expectations, Mattel posted a mixed report. A revenue decline of 3.7% year-over-year was 2 points better than analysts expected. Barbie doll sales in particular were strong. The 24% growth in sales of that product was the best increase in Mattel’s history. And excluding the impact from the Toys ‘R’ Us liquidation — which has had a significant effect on MAT stock — net revenue actually rose 2% YOY.
On the bottom line, the news wasn’t nearly as good. Adjusted EPS of 60 cents was a full 21 cents below Street estimates. Adjusted gross profit fell 380 basis points. While the revenue performance looked strong, Mattel had to pay for it. Rising costs led adjusted gross profit dollars to fall 10%. Combined with a moderate increase in operating expenses, adjusted EBIT loss widened $40 million to ~$160 million.
All told, it was a mixed quarter. And so the market’s somewhat volatile reaction to the report makes some sense.
Should Mattel Stock Have Risen?
So, was Q1 a good quarter for Mattel? Well, beauty is in the eye of the beholder. Any rational investor didn’t expect a rebound in earnings. Mattel’s aggressive cost-cutting measures haven’t fully kicked in — but will do so in the back half. An estimated $390 million in annual savings still is on the way, according to the company’s earnings presentation. That would alone would erase more than half the operating loss posted in Q1 — which is far and away Mattel’s seasonally weakest.
Meanwhile, the progress on the top line — particularly the growth excluding Toys ‘R’ Us — looks like a step in the right direction. But, looking closer, that might not be the case. 24% growth in Barbie sales sounds like an achievement, but sales in that category have been in steady decline — falling for each of the last four years. Barbie revenue fell 13% a year ago, meaning the two-year growth was under 8%. And that’s with six points of help from weaker currency this quarter.
Indeed, the sales growth, excluding Toys ‘R’ Us, benefited from a three-point currency tailwind. That aside, revenue still declined YOY. So, the unenthusiastic reaction to Q1 makes more sense, looking closer. It’s tough to see the quarter as showing some real progress in Mattel’s turnaround.
Is MAT Stock a Buy?
That said, Q1 doesn’t argue against a turnaround, either. And in the context of ugly results from rival Hasbro, Inc. (NASDAQ:HAS), Mattel earnings certainly could have been worse.
But I don’t see the long-term case for Mattel stock as improved based on this latest quarter — and I don’t think that case is all that strong to begin with. Back in July, I called MAT stock a value trap to avoid and even 30%+ cheaper, that’s still the case.
The biggest problem is Mattel’s debt. The company closed Q1 with $2.88 billion in long-term debt. That’s over 20 times its trailing twelve-month Adjusted EBITDA. To put that figure into context, a ratio above 5 generally is considered concerning. Mattel’s debt rating was cut recently as a result, and it had to suspend its dividend last year.
Even applying the remaining cost savings to the figure, Mattel’s leverage ratio still sits above 5. That means the company has to start growing organically — not through cost-cutting — and has to do soon. It also significantly undercuts the hopes that Mattel will be bought out by Hasbro or Walt Disney Co (NYSE:DIS). Those companies likely will be loath to assume debt at 100 cents on the dollar when bond investors are valuing that debt as low as 80 cents on the dollar.
More importantly, by any reasonable valuation measure, Mattel has to start growing again to justify even the current $14 share price. Cost-cutting alone doesn’t create a company with enough cash flow or earnings to be valued at $5 billion-plus. (Note that the forward price-to-earnings ratio assigned MAT stock, which includes 2019 cost-cutting benefits, still sits at over 29.) And that’s a big ask.
The loss of the Toys ‘R Us channel will hurt for some time. Barbie’s Q1 performance aside, its long-term growth looks relatively muted. The same is true of Hot Wheels. Elsewhere, brands like American Girl are in freefall. (Mattel is closing a production facility in southern Wisconsin as a result of lower demand.)
A turnaround is possible, but there’s not enough evidence that it’s likely — and Mattel stock isn’t cheap enough to bet on it just yet.
Q1 earnings, despite some positive headlines, don’t change that fact.
As of this writing, Vince Martin has no positions in any securities mentioned.