Turnaround Letter Buy-recommended Mattel (NYSE: MAT) reported strong 4Q profits that were well-ahead of investor expectations, sending its shares up 38%. A few days later, at the Toy Fair industry conference, the company provided guidance for 2019 that was below investor expectations, sending the shares down 18%. The net effect is that the shares remain up 38% year-to-date and the turnaround is making good progress. We reiterate our BUY rating with a $38 price target.
Mattel’s adjusted net income of $14.9 million was sharply higher than the $248 million loss a year ago. The current quarter was “clean”, with no net adjustments, while the year-ago quarter had $34 million of net adjustments.
While net revenues fell 5%, the underlying strength was more impressive. Excluding the effects of changes in foreign currency exchange rates and the Toys R Us bankruptcy, sales growth would have been well into positive territory. Gross sales fell 9% (in constant currencies), yet much of this reflects the unusually large rebates used a year ago to boost revenues. Better inventory control and product relevance helped reduce rebates by 40% in the quarter. The Toys R Us bankruptcy reduced gross sales by 8%.
Barbie and Hot Wheels, which represent about 44% of sales, continue to show impressive growth, while Fisher-Price, Thomas & Friends and American Girls, along with a smaller collection of brands, were noticeably weak.
Adjusted EBITDA of $186 million improved by $254 million from last year’s fourth quarter loss. For the full year, Adjusted EBITDA of $198 million grew by 61% from 2017.
The company sharply beat consensus estimates, driving Mattel’s shares up 38% in the days following the earnings report.
Mattel’s “Structural Simplification” strategy is working. With strong results so far, management raised their targeted savings of $650 million by the end of 2019. In addition, inventories at Mattel and retailers is in much better shape, receivables are 14% lower, capital spending has been cut in half yet all the key initiatives are being adequately funded. Their two-prong strategy of restoring profitability and revenue growth in the near-term, while capturing the long-term value of its brands over the long-term, is well-underway. The company has hired impressive new talent to launch upcoming new movies, TV shows and to further commercialize its highly-recognized stable of brands.
While its net debt is modestly higher than a year ago, the balance sheet is in a much less precarious position given the return to profitability. The nearest maturity is in October 2020.
The 2019 outlook at Toy Fair a few days later disappointed short-term investors
Mattel’s outlook, provided at the toy industry’s big New York conference, was lower than investors expected, pushing its shares down 18%. Despite the drop, MAT shares remain up 38% year-to-date.
The company guided for flat revenues net of currency changes, compared to the consensus estimate for a 3.3% increase. Guidance for Adjusted EBITDA of $350 million to $400 million was well-below the consensus estimate for about $480 million.
Our view is that short-term investors extrapolated the strong 4Q gains in profitability too aggressively. We believe the turnaround is progressing well. Flat sales with a few percentage points of currency headwind is a strong improvement after years of declines. If the company generates $375 million in Adjusted EBITDA and positive operating profits in 2019, with more improvements in 2020 and beyond as it outsources its manufacturing, improves still-laggard brands (which have had lower priority compared to its flagship Barbie and Hot Wheels brands) and adds to its cost-savings, Mattel’s longer-term shareholders will be rewarded for their patience.
Mattel estimates that it will have $450 million- $500 million in cash balances at year-end 2019, indicating that the company will be essentially cash flow break even this year.
Overall, the turnaround is progressing. Like most turnarounds, this one will take a while longer than short-term investors prefer.
We continue to rate shares of Mattel (MAT) a BUY with a price target of 38.
Disclosure Note: An employee of the Publisher owns MAT shares.