EUR 850.00 For Business Accounts Only

Morningstar | Road to Mattel’s Turnaround Improving, but Fisher-Price Could Offer Near-Term Brand Equity Headwinds

Barbie and Hot Wheels continued to carry the load for narrow-moat Mattel in its first quarter, with gross sales up 7% and 4% on an as-reported basis. Those two brands represented nearly 40% of sales, helping offset the ongoing declines the firm is experiencing in Fisher-Price and Thomas, which had gross sales that tumbled 8%. All in, this led to gross sales declines of 2% in the quarter, ahead of the 5% shortfall we had anticipated. Furthermore, structural simplification efforts began to pay off, driving better-than-expected expense leverage. The 38% adjusted gross margin beat our estimate by 300 basis points and improved 670 basis points year over year, while the 42.5% selling and administration ratio bested our forecast by 250 basis points and improved 1,370 basis points year over year, both aided by structural simplification. While we’d generally view massive operating margin leverage as impressive, a negative 15% adjusted metric implies significant room for improvement remains to be captured at Mattel. However, we also believe it displays the expense leverage inherent in the business as operating margin gains were captured on top of ongoing sales declines.

Mattel reiterated its prior full-year guidance, calling for low-single-digit as-reported sales declines, low-40%-range gross margin performance and EBITDA of $350 million-$400 million. Our prior forecast called for as-reported sales that contracted 2% (to $4.4 billion), gross margin of 42.6% and EBITDA of $356 million. In this vein, we don’t plan any material change to our $21 fair value estimate, which includes long-term sales growth of 2%-3%, meaningful SG&A leverage (750 basis points over the next decade to around 34% of sales), and an operating margin that reaches 15% in 2024. We view shares as undervalued (even after a double-digit gain in shares post-report) but note that with high uncertainty around the business, we believe shares are best suited for long-term investors, as interim headwinds remain.

While the firm is moving in the right direction, we still likely have another year before Mattel reaches its own short to midterm goals for restoring profitability and regaining top-line growth, particularly with added headline risk from recent concerns surrounding Fisher Price’s Rock and Play recall, which should act as a drag on the infant/toddler/preschool segment over the remainder of 2019. Given the company’s struggling performance over the past few years, it’s apparent that Mattel’s brand equity has been questionable across certain intangible assets, particularly the Fisher-Price and American Girl labels. While we think these particular brands continue to have decelerating brand equity, we think both Barbie and Hot Wheels have recently shown brand acceleration despite recent industry adversity, with sales from Barbie rising 14% and Hot Wheels climbing 7% in 2018 and ongoing momentum in 2019. That said, we plan to watch the portfolio in its entirety over the coming quarters to determine whether the impact from recent news surrounding Fisher-Price have more long-term staying implications, warranting a reset to a negative moat trend from our current stable moat trend rating. Sustained ROIC pressure could similarly indicate that the economic moat Mattel owns has eroded from narrow, which we believe will be difficult to ascertain for at least few quarters given that the company is finally wrapping the Toys 'R' Us liquidation period through the second quarter in 2018, skewing performance metrics.