EUR 850.00 For Business Accounts Only

Morningstar | Languishing Sales From Toys 'R' Us and International Pressures Continue to Affect Hasbro

Penalized by lost Toys 'R' Us revenue and ongoing issues with European inventory management, narrow-moat Hasbro's third-quarter sales fell more than 12%, significantly more than the low-single-digit decline we had forecast. While we anticipate both headwinds are transitory, we don’t expect either to conclude concisely and foresee continued top-line and profit growth pressure persisting into the final quarter of 2018, a factor we believe sent the shares tumbling. We plan to take a single-digit-percentage cut to our $95 fair value estimate and view the shares as fairly valued, trading around 20 times our 2019 earnings estimate versus mid-single-digit earnings per share growth over the next five years.

Hasbro is actively attempting to pivot, which it has successfully done when faced with difficulties in the past (for example, resurrecting growth in the games business earlier in the decade). With a modest reorganization set to save about $35 million in recurring expenses, Hasbro is attempting to address evolving industry conditions, but we maintain near-term caution regarding the visibility of success, as industry leaders have persistently ceded share in recent periods. For Hasbro, this is evidenced by year-to-date sales that have contracted 12% versus global toy sales that increased at a mid-single-digit pace over the first half of the year, according to NPD.

However, we don’t plan to alter our long-term outlook for Hasbro, which includes average top-line growth of less than 2%, EPS increases of below 4%, and returns on invested capital of more than 30% over the next five years. In our opinion, Hasbro still has some of the most powerful brands in the toy aisle, supporting demand and our narrow moat rating, and we anticipate that once it laps Toys 'R' Us closures (shuttered in the second quarter of 2018), it should begin to see a return to normalized growth.

Nearly all segments and geographies languished at Hasbro in the third quarter. The U.S. and Canada segment declined 7% and total international tumbled 24%, with as-reported declines of 29% in Europe, 16% in Latin America, and 14% in Asia-Pacific. The only bright point was in entertainment and licensing, which rose 45% (about 5% of total sales), benefiting from new content deals, the My Little Pony film contribution, and accounting changes. On the brand segment side, franchise brands (54% of revenue) declined 5%, with only four of the brands in the category (Baby Alive, Magic: The Gathering, Monopoly, and Play-Doh) posting increases. Partner brands (19% of sales) fell 37% and games growth was flat, while emerging brands could only clock 2% growth.

Despite sales that have declined materially, Hasbro has controlled its expense profile well, with its operating margin contracting just 10 basis points year over year to 20%. While the gross margin tumbled about 100 basis points to 58.2% as the company had to liquidate inventory abroad, lower royalties (to the tune of 110 basis points, at 6.7%) and advertising expenses (down 80 basis points, to 8.6%) helped offset pricing losses. Inventory improvement, with levels contracting 3%, is moving in the right direction, but we surmise there is more compression ahead. Balance sheet metrics remain clean, with plenty of cash (more than $900 million) and receivables down 16%, ensuring that the company’s dividend and leverage targets remain intact, and speaking to the overall financial strength of the business.