Narrow-moat Hasbro’s (HAS) second-quarter results conveyed the strength of the firm’s brand intangible asset, with franchise brands (56% of sales) including Transformers, Magic: The Gathering, and Nerf delivering sales that climbed more than 20%, leading to total sales growth of nearly 11%, above industry trends (4%). We interpret these results favorably, given that franchise brand Transformers: The Dark Knight has captured only around $128 million at the domestic box office this year, below Transformers: Age of Extinction at $245 million in 2014, according to Boxofficemojo.com, implying a narrower audience. More-favorable expenses in product development ($0.05), advertising ($0.03), and selling distribution and advertising ($0.03) contributed around $0.10 of upside in earnings per share to our model, which we plan to flow through to improve our 2017 outlook. We anticipate a modest increase to our $94 fair value estimate, but still view the shares as overvalued, trading above 20 times our 2017 EPS estimate. For reference, our model included 9% EPS growth on average over the next five years (versus 10% over the past five years). For investors seeking exposure to the industry, we view Mattel’s valuation as more attractive, trading at a 25% discount to our $29 fair value estimate.
We don’t plan to change our long-term outlook, which includes top-line growth that averages 5%, thanks to decent product innovation, low-single-digit domestic sales growth (about half of sales), and high-single-digit international growth. Additionally, as Hasbro scales we see incremental expense leverage. We don’t expect gross margins changing much, given exposure to content that is already high, but see marked improvement in the SD&A ratio over our forecast, which we see falling 150 basis points to 20% from 21.5% in 2016. While inflated in recent years, over 2007-12 Hasbro delivered SD&A metrics that fell below 20%. This leads to operating margins of 18% at the end of our forecast.
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Jaime M. Katz, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.