It Makes Perfect Sense to Fade This Big Rally in Hasbro Stock

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Hasbro stock - It Makes Perfect Sense to Fade This Big Rally in Hasbro Stock

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Surprise, surprise! Toy maker Hasbro (NASDAQ:HAS), one of the companies that was supposed to be crippled by the recent Toys R Us liquidation, reported much better than expected second quarter numbers. Revenues weren’t down all that much. Margin compression wasn’t that bad. And profit erosion wasn’t as awful as everyone feared for Hasbro stock.

In response to those better than expected numbers, Hasbro stock is up more than 10% to above $105. Fellow toymaker Mattel (NASDAQ:MAT) is up big, too.

But, I think this is a rally investors would be wise to fade.

At $105, the valuation simply doesn’t make sense for Hasbro. Revenues are in retreat. Margins are falling back. There are secular headwinds facing the toy industry outside of Toys R Us. And the stock trades at nearly 23X forward earnings, versus a five year average multiple of 17.5X and against a 7% revenue decline backdrop.

As such, I think Hasbro is way overvalued here, and will inevitably fall as investor enthusiasm fades.

Here’s a deeper look.

Things Aren’t That Bad at Hasbro

Hasbro’s impressive second quarter underscored one prevailing theme: things aren’t as bad at Hasbro as everyone feared.

The Toys R Us bankruptcy and liquidation was supposed to kill this company. Indeed, it did kill Hasbro in the first quarter of 2018. Revenues dropped 16% year-over-year, led by a 19% decline in the U.S. and Canada business and a 17% decline in the international business. Meanwhile, operating profit margins flipped from 9.2% to -11.2%.

But, the numbers got a lot better in the second quarter.

Revenues declined just 7%, a 9 percentage point improvement from the first quarter. The U.S. and Canada business was down just 7%. The international business was down just 11%.

Meanwhile, operating profit margins in the U.S. and Canada business actually improved slightly year-over-year thanks to a favorable product mix. Overall, operating profit margins compressed only 60 basis points year-over-year from 10.3% to 9.7%.

Those are much better numbers than what investors saw in the first quarter. The quarter-to-quarter improvement in growth rates and margin erosion is a strong sign that the worst from the Toys R Us liquidation is in the rear-view mirror, and that this company can return to positive revenue growth and steady margin expansion in the near future.

Overall, that is a positive development in the Hasbro growth narrative.

But Hasbro Stock Is Priced as if Things Were Great

The problem, though, is that Hasbro stock is already priced for this positive development, and a whole bunch more.

Hasbro now trades at nearly 23X forward earnings. The forward multiple on this stock usually trends around 17.5X. That means today’s valuation is a 30%-plus premium to the historical norm.

Also, today’s big valuation comes against the backdrop of not just negative revenue growth and margin erosion, but also against the backdrop of secular headwinds facing the toy industry.

At the core Hasbro’s issue isn’t the Toys R Us liquidation. It is a boom in internet and smart device usage among children. The average age for a child getting their first smartphone is now 10.3 years, so that means that all those 10-year-olds that were playing with Hasbro action figures are now playing on smartphones.

Plus, tablet usage among children has soared from 26% to 55% over the past several years, while internet usage has soared from 42% to 64%.

In other words, children aren’t playing with Hasbro toys as much as they used to. Instead, they are playing on smart tablets and smartphones. This trend won’t slow any time soon. Indeed, things may only get worse for Hasbro as technology continues to grow in popularity.

From this perspective, today’s premium valuation, based on the idea that Toys R Us headwinds are near-term noise and things will get back to normal soon, makes no sense. Hasbro is facing a plethora of demand headwinds, only one of which is from Toys R Us.

Because of this, as Hasbro moves past Toys R Us headwinds, the company will still fail to get revenue growth up to its 5% historical standard due to persistent demand headwinds as a result of technology adoption among children. As this happens, and it becomes clear that slow growth is the new standard for Hasbro, the stock will inevitably crumble back to a more normal valuation.

Bottom Line on Hasbro Stock

Hasbro’s second quarter numbers were much better than expected, and point to the fact that this company is largely past the Toys R Us liquidation headwind.

But, that doesn’t mean it is time to buy Hasbro stock. The company has structural challenges due to waning toy demand as a result of growing smart device adoption. So long as these structural challenges remain, Hasbro will have trouble holding onto gains.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/07/fade-rally-hasbro-stock/.

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