Mattel, Hasbro Look Undervalued

Jaime Katz: We recently stepped back and reassessed the opportunity stemming from major global markets that toy companies have exposure to, including the U.S., Europe, and China. We concluded that longer term, the industry should only be growing at a low-single-digit rate, given that youth population in the U.S. is rising just above 1% every five years between 2015 and 2040, with both Europe and China set to experience youth population declines over the same time frame. However, with market share gains and the ability to take price through innovation, we still anticipate positive growth overall for both the industry as well as Mattel and Hasbro.

Additionally, we see the majority of top-line gains stemming from increases in international consumers and a rising exposure to content-driven product. We project international to increase to more than 50% of sales over the next decade from Mattel, while at Hasbro we think International sales will rise to represent about 49% of the total sales mix, both of which are higher than these companies have reached over the last five years, as the firms build awareness through content-based properties, which tend to have a wider global reach and thus cast a broader net over consumers.

We also reconsidered the retailing environment in light of the Toys 'R' Us liquidation, and the balance sheet confirms that retailers are putting incremental pressure on their vendors. We see it in numbers like inventory and receivable days, which have been lengthening, pressuring the cash conversion cycle of the toy businesses. We don't think pressure from Toys 'R' Us will exist perpetually and expect that by second quarter the companies should have any overhang cleared from residual receivable or financial risk surrounding the liquidation.

Both Mattel and Hasbro are trading at a discount to their respective $21.50 and $97 fair value estimates, and we view Mattel shares as more undervalued at this time. Given the margin of safety, we believe the name warrants interest at its current price.