HAS - Hasbro: Macroeconomic Challenges Is Taking Its Toll

2023-11-08 03:29:23 ET

Summary

• Hasbro's third quarter 2023 results showed declining revenue and poor performance in the toy and entertainment industries.
• Franchise brands experienced growth, but partner brands saw a decrease.
• Inflation is putting pressure on Hasbro's top and bottom line, and the outlook remains bleak.

Overview

Note that I previously had a hold rating for Hasbro ( HAS ) stock as I believed that given the poor traction, there's a good chance management will need to update its FY23 guidance. In the event that third quarter 2023 shows no signs of improvement, I think the market will punish the stock even more as investors become risk-averse because the fourth quarter will probably need to be exceptionally strong in order to meet guidance.

I am reiterating my hold rating as, indeed, third quarter 2023 shows no signs of improvement and in fact reported declining revenue and mix segment performance. In addition, management revised its FY23 guidance downward to reflect declining revenue for the full year. Due to this, the stock price fell 25% the last time I touched on it.

Recent results & updates

The third quarter results show that HAS is facing a challenging macroenvironment in the toy and entertainment industries. HAS’s $1.5 billion in total revenue was 10% less than the previous year. Planned business exits and macro-category trends contributed to an 18% decline in consumer products. If these withdrawals were taken out, the segment ended 12% lower, which shows the challenge in this industry likely driven by high inflation. The $343 million adjusted operating profit was 27% higher than the previous year. A favorable product mix—most notably, high-margin digital game revenues—as well as lower royalties and operating costs contributed to the increase. An unfavorable tax rate impact and additional interest expense were partially offset by the higher operating profit, which resulted in adjusted earnings per share of $1.64, up 15% from the previous year.

Examining HAS's brand performance , Franchise brands saw 8% growth in the quarter. These brands, which make up slightly more than 60% of its sales, are its largest and most lucrative brands. HAS achieved notable revenue growth in the third quarter for franchise brands in the gaming industry, such as Hasbro Gaming, Magic, and Dungeon & Dragons. Moving on to partner brands, it saw a year-over-year decrease following 2022's outstanding results from Marvel and Star Wars. As stated by management, HAS will broaden its partner brand lines and categories, such as its recently announced partnership with Marvel and MAGIC. As a result, I anticipate improved results in the upcoming quarters. Partnerships with the Walt Disney Company remain a top priority for HAS. Observing the operating margin now At 22.8% for the third quarter, the adjusted operating margin was 6.7 margin points higher than it was the previous year.

Moving to HAS full-year 2023 revenue guidance, due to declines in the toy category as a whole, management now projects a 13% to 15% decline in overall revenue as a result. This guidance now assumes that the consumer products business will be in the mid- to high teens when examining the primary segments. As they start to outpace the market declines from the previous year, HAS is preparing for a slight improvement in the fourth quarter based on the category trend in the third quarter. Retailers, in my opinion, will continue to exercise caution when it comes to their inventory positions, which will affect the usual patterns of holiday orders. I still believe that Wizards of the Coast will see strong single-digit revenue growth as a result of their successful magic and digital game businesses. In the third quarter, the lion's share of BG3 revenue was realized. As the revenue from the game will continue to be recorded in accordance with unit sales, I anticipate a slight positive contribution in the next quarter.

In my view, inflation is taking its toll on HAS. As toys are elastic goods, they are very sensitive to price changes. As long as inflation remains persistent and the interest rate is at an all-time high, I expect this to put pressure on HAS's top line and bottom line. At the current stage, inflation is persistent, and central banks all around the world are working tirelessly to bring it under control. At this juncture, the outlook for HAS remains bleak and full of roadblocks.

Valuation and risk

According to my model, HAS is valued at $45.46 in FY23, representing an insignificant 5% increase. This target price is based on my growth forecast of declining growth for FY23. During the earnings call, management guided a decline in revenue and provided this assumption. In the third quarter, HAS is clearly facing challenges in the market it operates in, as top-line revenue and segment revenue all declined by double digits. In addition, HAS third quarter results also showed mixed performance. Although franchise brands grew, partner brands saw a year-over-year decrease. I believe the main driver of these challenges is inflation, as toys are not necessities and are very sensitive to price changes as well as disposal income. As long as inflation stays persistent, I expect it to put pressure on HAS’s revenue growth.

As of now, HAS's forward P/E stands at 12.12x, in line with its peers median P/E. In terms of net margin, HAS’s margin is ~14%, which is in line with its peers. However, in terms of EBITDA margin, HAS’s margin is 12%, which is lower than peers' median of 17%. Given the fact that HAS has a higher gross margin of 67% compared to its peers' 54% but derives the same net margin and lower EBITDA, it means that HAS’s cost management is not as effective as that of its peers. Given this argument, I believe HAS forward P/E should be trading at the lower end of its peer’s range. At 10.98x, my target price is in line with its current traded price. Therefore, given all the headwinds discussed above as well as its weaker comparables, I maintain my hold rating for HAS.

One upside risk to my hold rating is improving macroeconomic conditions, such as lower inflation. When inflation falls, prices fall, which tends to encourage retail spending. If interest rates were to fall, it would increase consumers’ disposable income, which would have a positive effect on spending as well.

Summary

In summary, HAS reported weak third quarter 2023 results where revenue declined by double digits. This decline was driven by the challenging macroenvironment in the toy and entertainment industries. When analyzing its brand's performance, it showed mixed performance, where franchise brands grew but partner brands contracted. As a result of the challenging macroenvironment, management guided a decline in overall revenue for FY23, and the decline is in the double-digit range, which is alarming. In my view, inflation is taking its toll on HAS. Toys are elastic goods. In light of all these headwinds and poor results, I maintain my hold rating for HAS.

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