EUR 850.00 For Business Accounts Only

Morningstar | Hasbro Wraps 2018 With Messy Quarter, but Brand Intangible Asset Still Healthy; Shares Fairly Valued

Narrow-moat Hasbro reported results that were weaker than we had anticipated, as cost deleverage on lower sales (which fell 13% in the final quarter) had a wider impact on profits. With performance muddied by the Toys ‘R Us bankruptcy, previously announced reorganization costs, and impairment charges surrounding Backflip Studios, it was difficult to find a silver lining in the firm’s results. While Hasbro continues to pivot to adjust to the evolving European landscape (which narrow-moat peer Mattel has also called out as problematic), it could take a few quarters to adjust the business accordingly. However, we think as we lap the TRU bankruptcy in the second half of 2019 and realign the distribution network to further absorb lost opportunities from the TRU liquidation, sales and profit cadence should normalize. Given the limited insight to 2019 plans, we don’t expect to make any change to our $92 fair value estimate until we obtain incremental detail on strategy and expenses at the company’s annual investor day at Toy Fair next week. We view shares as fairly valued, at a mere 6% discount to our intrinsic value.

While fourth-quarter profits were disappointing, we don’t think they will lead to a protracted period of financial distress for the company. With brands that continue to resonate with consumers, and a robust media slate to support visibility in 2019 (Captain Marvel, Avengers, Spiderman, Frozen 2, Star Wars IX), we expect top-line growth to resume in 2019. Our long-term outlook calling for average sales growth of nearly 4% and operating margins that expand modestly (averaging 17%, from 13% adjusted in 2018) over the next decade is contingent on Hasbro continuing to capitalize on its Brand Blueprint, telling its stories across multiple channels and endeavors to endear consumers and facilitate demand. We think Hasbro will continue to invest in creative elements of the business in order to support this growth.

Nearly all metrics were significantly lower than we forecast by a wider margin, with fourth-quarter sales contracting 13% versus our low-single-digit decline estimate. All segments were weaker than anticipated, with franchise brands falling 8%, partner brands declining 20%, gaming down 22%, and emerging brands rising just 5%, as the company experienced a wider impact from liquidated product than originally expected. This, in turn, impacted nearly all cost metrics by our estimate. Adjusted cost of goods sold was more than 300 basis points above our forecast, at 43.3%, expanding 390 basis points year over year due to higher close out sales and an obsolescence reserve increase. Adjusted selling, distribution, and administrative expenses were higher than we thought by around 100 basis points, but lower on an absolute basis, as compensation and bonus expense declined.

But not all news was bad, and the company cleared a very difficult period with global point-of-sale metrics up for franchise brands, emerging brands, and gaming for both the full year excluding TRU, indicating that underlying throughput remains favorable for the firm. Additionally, retail inventories were down more than 20% in both the U.S. and Europe, setting up Hasbro to enter 2019 with a clean slate of products at retailers that could capture better full-priced sell through ahead. Efforts to streamline inventory at retailers have put a crunch on shipment cadence, but ultimately we believe this will normalize over time, and has been a pressure that has been ongoing in recent years as big box operators attempt to manage their own cash conversion cycle. Despite pressures from both evolving consumer demands and a shifting retailing base, we still believe Hasbro could generate adjusted returns on invested capital averaging above 30% over our forecast, implying excess economic rents should continue to be generated, supporting our narrow moat rating.