Investors initially saw first-quarter earnings from Mattel (NASDAQ:MAT) as a blowout win. MAT stock gained more than 10% in after-hours trading. It opened the following day up over 8%. Yet Mattel stock would eventually close down over 1%.
Looking closer at the headline beat, investors didn’t like what they saw quite as much. And it’s hard not to see an echo of what happened after last year’s first quarter. As I wrote at the time, Mattel stock opened the day after Q1 2018 earnings up 9%. By the end of that trading day, the gains were mostly erased. Less than eight months later, MAT stock would hit a 17-year low.
To be sure, it’s not guaranteed — or even likely — that Mattel stock will tank in 2019 as well. And there was some good news in Q1. But the toymaker still has very serious problems. These headwinds sunk MAT stock last year. This year, they’re likely to at best keep a lid on the recent rally.
From a broad standpoint, there are two ways to look at Mattel stock. Bears see a business in long-term decline. Products like Barbie and Matchbox cars will likely see future sales decreases. That implies falling profits, potentially adding to Mattel’s debt load of over $2.8 billion.
To bulls, it’s an attractive turnaround play. Cost-cutting should help margins. One-time headwinds, most notably the 2017 bankruptcy of Toys “R” Us, will fade. Real value remains in the company’s intellectual property. New franchises from Disney (NYSE:DIS) and other content creators will create new merchandising opportunities for Mattel and rival Hasbro (NASDAQ:HAS). And both companies are among potential buyers of Mattel for that IP, particularly if the company can drive margin improvement in coming years.
Both sides probably see Mattel earnings as supporting their respective cases. Mattel revenue was much stronger than expected, dropping just 2.7% against consensus expectations for an 8% decline. Net revenue actually rose 1% in constant currency, per the Q1 release.
Additionally, Barbie sales rose 13% after a 24% rise the year before. Hot Wheels revenue climbed 9%. Adjusted gross margins expanded 670 basis points to 38%. Operating loss in Q1 — Mattel’s smallest and least profitable quarter — narrowed by nearly $150 million.
However, the critics would argue it’s simply not enough. Mattel still posted an adjusted operating loss over $100 million. The recall of Fisher-Price sleepers will lead to a loss of $30 million-$35 million in full-year revenue. Cost-cutting is driving the gains: management said the company achieved $610 million of annual run-rate savings.
Those savings should have driven $155 million in earnings improvement in the quarter, which is basically what we saw. There’s only about $40 million more to go. Theoretically, once those savings are exhausted, so too is a key tailwind for MAT earnings.
What Now for Mattel Stock?
So, the obvious question coming around of earnings is, what now? Mattel didn’t raise full-year guidance, keeping its range at $350 million-$450 million in adjusted EBITDA. Revenue is expected to be flat. The company is planning for more savings in 2020 and beyond thanks to a new “capital light” model. But even with some help, Mattel stock remains a long way from cheap.
For example, the high end of EBITDA guidance suggests minimal profits and light free cash flow. That’s hardly enough to support a current $4.4 billion market capitalization. Net debt still is over 6x EBITDA, a concerning figure. As a result, Mattel’s long-term bonds (due 2040 and 2041) trade at “junk” levels.
In other words, Mattel still is pricing in growth from here that goes beyond cost savings alone. And even with the optimism toward Q1 sales, it remains exceedingly difficult to see from where that growth will come. Video games still are attracting more children than toys. Future licensing opportunities won’t come cheap.
Meanwhile, the company’s handling of the Fisher-Price sleeper — which is reportedly linked to a shocking 32 deaths — seems questionable at best. So does the assertion from management that the recall would have no impact on the long-trusted Fisher-Price brand.
Aside from the tragic human cost, the handling highlights long-running management concerns, as Bronte Capital pointed out in a scathing blog post. To summarize, Mattel spent billions buying back MAT stock, and shareholders now are paying the price.
Risks to MAT Stock
Again, I’m not arguing that Mattel stock will repeat recent history and lose over a third of its value. But further declines do seem likely.
MAT stock isn’t cheap from an earnings basis. Management concerns persist. And it’s worth noting that video game companies like Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI) — which enjoy higher demand from American kids — are much cheaper than they were a year ago.
More broadly, Mattel stock has been going in the wrong direction for years now. Sure, we’ve seen some sharp bounce-backs from spike lows. But MAT is fading again, as it has for years now. Not enough exists in the Q1 results, even with a consensus beat, to argue convincingly that this time will be different.
As of this writing, Vince Martin has no positions in any securities mentioned.