HAS - Hasbro: Challenging Near-Term Prospects

2023-09-11 09:29:20 ET

Summary

• Weak 1H 2023 with revenues and profits dropping across all segments.
• Near-term prospects are challenging due to elevated inventories and weakening consumer spend on discretionary purchases.
• Digital games and Blueprint 2.0 strategy can drive growth and expand margins.
• Execution risks are significant.

American toy company Hasbro ( HAS ) is going through a rough patch with elevated inventories and weakening consumer spend. Blueprint 2.0 strategy could support medium-term growth and higher profitability. Execution risks however are significant.

Company overview

Hasbro is an American toy and games company. Their portfolio of iconic brands includes Peppa Pig, Transformers, Play-Doh, Dungeons & Dragons, Magic: The Gathering (collectively categorized as "Franchise Brands" which account for over 60% of revenues), as well as other partner brands including Star Wars and Marvel.

The company has four reportable segments:

Consumer Products: This segment engages in sourcing, marketing, and sales of toy and game products around the world, under the company's own brands as well as through licensing partnerships. This is currently Hasbro's biggest segment, accounting for over half of revenues.

Wizards of the Coast and Digital Gaming: This segment engages in the development and sale of trading card, role-playing, and digital games based on Hasbro and Wizards of the Coast properties. This is Hasbro's second-biggest segment by revenues, accounting for about a third of total revenues. This segment is currently Hasbro's only profitable segment and has long been its most profitable with a segment operating margin of around 40% in FY2022 compared with 6% for Consumer Products, and 2% for Entertainment.

Entertainment: This segment engages in the development, production, and distribution of film, television, children's programming, digital content, and live entertainment. This is currently Hasbro's smallest and least profitable segment.

1H 2023: Revenues and profits down across all segments

For 1H 2023, revenues dropped 12% YoY to $2.2 billion. All segments saw revenue declines.

• Consumer Products revenues were impacted by the expiration of license agreements for Partner Brand products Disney Princess and Disney Frozen, and lower products sales for Marvel and Star Wars, which benefited from a variety of entertainment releases in 2022. These revenue declines were partially offset by revenue increases from Transformers products supported by the theatrical release of Transformers: Rise of Beasts in June 2023.

• Wizards of the Coast and Digital Gaming revenues were impacted by lower revenues from tabletop gaming products due to the timing of card set releases compared to the first six months of 2022. These revenue drops were partially offset by higher digital gaming revenues as well as the impact of a full six months of revenues in 2023 from D&D Beyond, which Hasbro acquired in Q2 2022.

• Entertainment segment revenues were partly impacted by the exit of certain non-core businesses last year.

The company swung to an operating loss of $170 million compared with a profit of $339.1 million in the same period last year, partly due to lower revenue volumes, higher sales allowances to sell through inventory, higher marketing and advertising spend associated with certain entertainment releases in 1H 2023, and a $296 million non-cash impairment charge associated with the impairment review the Company's Film and TV reporting unit. Profits declined across all segments.

Near term, moderating inflation may ease margin pressures but weakening consumer spend on discretionary purchases suggests bleak revenue prospects heading into the holiday season, barring any material reduction in interest rates. Competitive pressures are also running high from Mattel, whose box office hit Barbie movie may help capture a greater share of consumers' toy spend over the coming quarters.

Hasbro's inventory levels, although declining YoY, remain relatively high compared to historical levels. Inventory amounted to about a third of Hasbro's current assets at the end of Q2 2023 compared with just 13% in Q2 2021 (before supply chain bottlenecks began to surface). High inventory and a weak demand environment may impact free cash flows, which are so far significantly lower than the same period last year; 1H 2023 free cash flows amounted to $7 million compared with $72 million in 2H 2023.

Management expects revenues to dip 3%-6% in FY2023. Consumer Products is expected to be down mid-single digit. Wizards of the Coast and Digital Gaming revenues are expected to increase in the single digits (compared to mid-single digit forecast previously). Entertainment is expected to decline 25%-30% taking into account the impact of the ongoing writers' and actors' strike.

Digital games potential growth engine, licensing strategy potentially margin accretive

Hasbro's revenues have grown at a 3.6% CAGR over the past decade. Although part of it may have to do with pandemic-induced supply chain bottlenecks and inventory stockpiling colliding with weakening consumer spend, part of it may also be structural as digital games and other online entertainment increasingly grow in popularity over traditional tabletop games and physical toys.

Looking ahead, prospects for physical toys, one of Hasbro's core businesses, are challenging. The physical toy market is saturated, extremely competitive, and projected to only see modest growth over the coming years (projected in the low-single digits).

Hasbro is adapting to changing consumer preferences with its Blueprint 2.0 strategy which aims to slim down the business to focus on fewer bigger and more profitable brands, as well as expand its digital gaming business among other aims. Digital Games is currently a small business for Hasbro (accounting for just a fifth of revenues in their Wizards of the Coast and Digital Gaming Segment), but this has the potential to be a meaningful growth driver as digital games rise in popularity around the world.

In North America, Hasbro's biggest market accounting for 60% of total revenues in FY2022, digital games are projected to grow in the high-single digits. Growth forecasts are roughly the same internationally as well.

Hasbro already has a collection of strong franchises which they can leverage on to build their digital gaming assets. With game development budgets on the rise, Hasbro is taking the asset-light approach, choosing to focus on licensing as partnerships with game studios. This strategy may be margin accretive as well.

Blueprint 2.0 strategy could support growth and increase margins

Certain areas of focus under their Blueprint 2.0 strategy stand out as potential growth or margin contributors. Management is aiming to achieve mid-single-digit CAGR revenue growth to reach more than $8.5 billion in revenues by 2027.

Focusing on a few profitable brands while exiting unprofitable ones could enable them to refocus resources towards brands with better potential, helping the company achieve their target of having three $1 billion brands by 2027 , up from just one currently (Magic: The Gathering became the company's first billion-dollar brand last year). Additionally, a sharpened focus on a few promising brands may support margins through better advertising ROI. A smaller but stronger brand portfolio could expand potentially margin accretive licensing opportunities which together with cost-cutting efforts (management is aiming to deliver $250-300 million in annualized run-rate cost savings by 2025) could support the company's target of reaching 20% operating margin, up from 16% currently. Hasbro laid off about 15% of their workforce, and the sale of eOne for $500 million announced last month, will be used to pay down at least $400 million in debts, helping shave off interest expenses.

However, this may be offset by potentially hefty brand-building investments, necessary to reach their target of three billion-dollar brands.

Risks

Competitive and execution risks

Hasbro's Blueprint 2.0 strategy has merits, however, execution is key. Digital games, a key growth pillar, is a highly competitive market, and Hasbro is up against stronger players like Microsoft who has the advantage of bigger pockets, in-house game development capabilities, as well as game distribution channels.

Strategic missteps may hinder the company's aim of having three $1 billion brands, or worse may hurt existing ones; late last year BofA analysts for instance said Hasbro was hurting their Magic: The Gathering's ecosystem by squeezing out money from the brand through an oversupply of cards, potentially "destroying the long term value of the brand" and threatening sales. Fans are already reportedly frustrated with Hasbro.

Conclusion

Hasbro has a buy analyst consensus rating.

After years of low-single-digit growth, Hasbro's Blueprint 2.0 strategy could accelerate growth slightly to their targeted mid-single digit while operating margins could potentially increase as well. Execution risks however are significant.

The stock currently trades at a forward P/E of 17 (higher than the sector median of 14), a price/book of nearly 4 (higher than the sector median of 2.1).

Considering near-term challenges and cloudy medium-term prospects due to significant competitive and execution risks, the risk/reward is not attractive at this point. The stock could be viewed as a hold for investors willing to tolerate the risks.

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