Season Looks Bright for These Toymakers

Jaime Katz: While the Toys 'R' Us bankruptcy weighed on third-quarter performance at toy distributors Mattel and Hasbro this year, we don't think toy sales will be left in the cold this holiday season. In fact, given the current economic state of the consumer, with low unemployment, high consumer confidence, and rising home and equity prices, we surmise the willingness of consumers to spend on such discretionary categories should prove strong in 2017.

The National Retail Federation has indicated that total Black Friday sales have risen the most since 2011, to the tune of an estimated 4%, and it appears Cyber Monday has captured another double-digit gain, providing some promise for toy company sales. The final quarter of the year remains a key selling season for the toy distributors, with Mattel and Hasbro historically booking about a third of its revenue in the final quarter of the year, and about two thirds in the second half of their fiscal years.

While Mattel will likely continue to clean up its inventory throughout the holiday season, leading to possible near-term market share declines, we anticipate Hasbro will continue to gain market share, helped by another quarter of solid content that supports product demand. We have these figures embedded in our sales outlook, which implies high single digit top-line growth of Hasbro with low single-digit sales declines for Mattel in the fourth quarter.

We still view Mattel as the more undervalued of the two companies, trading at about a 30% discount to our $26 fair value estimate. While we think the company's turnaround will continue to occur at a modest pace, we believe there is strong brand equity behind the company's core business that it can monetize more opportunistically ahead. Moreover, we think others believe so, too, given chatter of Hasbro's recent attempt to tie up with Mattel just a few weeks ago. While we don't think a pairing is imminent, if turnaround efforts fail to jump-start the top line over the next year, we'd expect to hear more murmurs in the future about a potential tie-up.