Mattel Inc. (NGS: MAT), the maker of popular toy brands such as Barbie, Hot Wheels, Fisher-Price and UNO could turn out to be one of the best stocks out there. The company is transforming its business with help from a new film franchise intended to drive demand for its toys. It has developed live-action films with major studios (Sony, Warner Brothers, Paramount and MJM) as well as animated programming on Netflix, and is also expanding agreements with Disney and Pixar to develop products for future films. In addition, Mattel has stepped up efforts to increase online sales (up 50% in 3Q) following the bankruptcy of Toys ‘R’ Us.
While Mattel posted impressive results in 3Q20, we remain concerned about delays in movie production caused by the pandemic and about the company’s high debt and ongoing restructuring efforts. We also expect it to return to profitability by the end of 2020.
Mattel shares have gained momentum. The beta on PM is 1.50.
The company reported 3Q net sales of $1.6 billion, up 10% from the prior year. The adjusted gross margin of 51% grew 410 basis points and adjusted operating income of $401 million rose 131%. Adjusted EBITDA rose 90% to $470 million and adjusted diluted EPS increased 265%. Year-to-date free cash flow improved by $65 million to negative $524 million. However, management indicated that free cash flow over the last four quarters was a positive $130 million.
The company has generated $875 million in cost savings from its ‘structural simplification’ program, above its target of $650 million, and is on track to exceed $1 billion by the end of 2020. As part of this effort, management closed three plants in 2019 (in Mexico, China and Indonesia) and plans to close additional plants in the future the under its ‘capital light’ program.
Management expects 2020 adjusted gross sales to be flat to up 1%. It also looks for an adjusted gross margin of 48.5-49% (up 350-400 basis points) and adjusted EBITDA of $625-$650 million (up approximately 40% from previous guidance).
EARNINGS & GROWTH ANALYSIS
Mattel has four segments: Dolls (38% of revenue). Third-quarter results by segment are summarized below:
On the expense side, the company’s ‘structural simplification’ and ‘capital-light’ cost savings initiatives have benefited gross margins by 150 basis points. Selling & administrative expenses declined 6% and were 20% of sales.
Implying flat year-over-year sales. We are also raising our 2020 estimate to earnings of $0.43 per share from a loss $0.38 per share, and our 2021 EPS estimate to $0.45 from $0.30.
FINANCIAL STRENGTH & DIVIDEND
The company has access to $1.6 billion in senior secured revolving credit and has extended this agreement through 2022. Management believes that Mattel has sufficient liquidity to manage through the pandemic and pursue its long-term strategies.
Total long-term debt at the end of 3Q20 was $3.5 billion, flat with the prior year. The total debt/capital ratio was 90%, up from 88% a year earlier. Previously, Mattel had $850 million in debt coming due between 2020 and 2023. However, in 4Q19, the company refinanced maturing debt to provide additional financial flexibility. It has no debt repayments until March 2023. Mattel’s debt is rated BB-/speculative by Standard & Poor’s.
The company suspended its dividend in October 2017. It is using the $50 million in quarterly savings to expand its business.
MANAGEMENT & RISKS
In April 2018, the company announced the resignation of CEO Margo Georgiadis after only 14 months on the job. She has been succeeded by Ynon Kreiz, the former CEO of digital media provider Maker Studios, which was acquired by Disney in 2014. In July 2020, Mattel announced that Anthony DiSilvestro would replace Joe Euteneur as CFO. The change follows a 2019 whistleblower probe that revealed accounting weaknesses at Mattel. Mr. DiSilvestro joined Mattel in June from the Campbell Soup Company, where he served as CFO.
Mattel’s success depends on its ability to stay ahead of trends in the toy industry, drive demand for its products through media ventures, and anticipate the changing tastes of children. This has become increasingly important as product lifecycles have shortened. If Mattel is able to stay ahead of new trends and drive demand for its products, its earnings and stock price should benefit; however, if it falls behind and fails to keep consumers engaged, it could see lower sales and earnings and corresponding declines in the stock price.
Mattel Inc. is a designer and manufacturer of a wide range of children’s toys. Its most popular brands include Monster High, Barbie, Hot Wheels, Fisher-Price, and American Girl. Mattel also develops and markets toys based on popular movies, such as ‘Cars,’ ‘Toy Story,’ ‘Batman’ and ‘Superman.’ In 2019, Mattel began the Mattel Film franchise, which includes films, television, digital gaming, and live events.
On a fundamental basis, the shares appear fully valued at 29-times our 2021 EPS forecast, above the historical average P/E range of 12-20. As such, our rating remains HOLD. We are maintaining our long-term BUY rating, however, as we believe that the company is moving in the right direction through its film franchise and cost-savings efforts. We also expect it to return to profitability by the end of 2021.