2023-05-30 09:57:06 ET
Summary
- Hasbro shares have returned a loss of about 7.15% in the past 4 ½ months.
- The company's dividend is considered reasonably secure, but the valuation is not yet compelling enough to buy more shares.
- The market is assuming that Hasbro will grow earnings at a rate of ~3.25% in perpetuity, which I consider to be slightly optimistic.
It's been about 4 ½ months since I added to my Hasbro Inc. (HAS) position, and in that time the shares have returned a loss of about 7.15% against a gain of 5.75% for the S&P 500. The company has reported earnings since, obviously, so I thought I'd review yet again to see if it makes sense to buy at the moment. I'll make that determination by looking at the financial history, paying particular attention to the sustainability of the dividend. I'll compare all of that to the valuation. If the shares are cheap enough, I'll buy more. If they're not, I'll not. If things look sufficiently catastrophic, I'll take my lumps here.
I know you're a fairly busy crowd of people, and so you don't want to waste your precious time. I can imagine you planning beautiful vacations to exotic locations, or doing meaningful work in the field of genetic research, or deciding which supermodel to hang out with in June. I'm busy, too. Speaking of Hasbro, for instance, I'm planning a few sessions for the players in my Dungeons & Dragons session. I don't want to brag, but I'm the Dungeon Master for this group. Anyway, because we're all busy, I understand that you might benefit from a quick synopsis paragraph that gives you the gist of my thinking in a single summary paragraph. This allows you to get in, get the gist of my perspective, and then get out before you get covered in too much "Doyle mojo." You're welcome. While I'm holding my position, I'll not add at current prices. The reason for this is that although I think the dividend is reasonably secure, the valuation isn't yet compelling enough. If the shares continue to tank from here, I'll celebrate by buying more, but for the moment I'm holding.
Financial Snapshot
The FY 2022 was troubled, obviously. Revenue and net income in 2022 were down by 8.8% and 53.3% respectively. This troubling because 2022 was hardly a banner year for the company. For instance, net earnings that year were even worse than they were in 2018, which was the previous low. While revenue in 2022 was about 24% higher than it was in 2019, net earnings were down by 61%. If you read my stuff regularly, you know that I'm not a fan of declining earnings in the face of rising revenues. In fact, net earnings in 2022 were about 10% lower than they were in 2020. You may recall that economic activity in 2020 was hampered by a global pandemic, so the most recent financial year was troubled.
The biggest problem in 2022 here, in my view, was the fact that revenue was down by $564 million, and that's what caused most of the drop in earnings. We can't blame the drop on a one-time event. The other significant financial change from 2021 to 2022 was the 16% uptick in selling, distribution, and administrative expenses, from $1.433 billion to $1.666 billion. There's really no way to sugarcoat it. The financial year 2022 was bad in my view.
Zooming in on the most recent quarter, the theme remains the same. Revenue and net income are both worse than they were last year. Revenue was down by about 14%, and net earnings swung from a positive $63 million this time last year to a loss of $22.1 million this year.
On the bright side, long term debt declined by about $45 million, though net interest expense was up by about 2%.
Dividend Sustainability
The financial history here is interesting, I suppose, but investors are obviously more interested in the future. In particular, I think the sustainability of the $385 million dividend is of particular interest because dividends are supportive of price, and because dividends provide investors with a relatively predictable stream of cash flows. Because I'm driven by an insatiable need to give investors exactly what they want, I will spend some time writing about the dividend now.
Although I'm as much of a fan of accrual accounting as the next finance nerd, when it comes to dividends and their sustainability, I like to review the size and timing of future cash flows, and cash obligations.
I'll start with the obligations. I've plucked the following out of page 100 of the latest 10-K for your enjoyment and edification. The item that pops out to me is the $750 million of debt that's due next year.
Against this obligation, the company has about $386 million in cash on the balance sheet. In addition, they've generated an average of $705 million cash from operations over the past four years. At the same time, they spent an average of $1.158 billion on the business over the same time. This figure is distorted by the $4.4 billion spent on acquisitions in 2020, though, and may not reflect ongoing effects. If we strip out this one-time event, the average investment in the business over the past four years drops to only $55 million. Thus, I think it fair to write that, assuming they don't make any new acquisitions over the next few years, they'll have sufficient resources to make this $750 million debt payment. Thus, I think the capital structure will be much improved next year, and I think the dividend is reasonably well covered. I don't expect much growth, but I would be very surprised by a suspension or a cut.
Given that, I'd be happy to add to my position if the valuation is reasonable.
The Stock
My regulars know that I've talked myself out of some profitable trades by insisting on the fact that share valuations need to match my definition of "reasonable." In my defence, I'd point out that I'm of the view that it's better to miss out on some gains than lose capital. My regulars also know that I consider the "business" and the "stock" to be quite different things. Every business buys a number of inputs and turns them into a final product or service. The stock, on the other hand, is an ownership stake in the business that gets traded around in a market that aggregates the crowd's rapidly changing views about the future health of the business, future demand for magic cards, views about Hasbro's tendency to overprint cards , future margins, and so on. The stock also moves around because it gets taken along for the ride when the crowd changes its views about "the market" in general. The stock may be affected by the pronouncement and interpretation (or misinterpretation) of some central banker. The idea that I want to get across here is that the stock is affected by a host of variables that may be only peripherally related to the health of the business, and that can be frustrating.
This stock price volatility driven by all these factors is troublesome, but it's a potential source of profit because these price movements have the potential to create a disconnect between market expectations and subsequent reality. In my experience, this is the only way to generate profits trading stocks: By determining the crowd's expectations about a given company's performance, spotting discrepancies between those assumptions and stock price, and placing a trade accordingly. I've also found it's the case that investors do better/less badly when they buy shares that are relatively cheap, because cheap shares correlate with low expectations. Cheap shares are insulated from the buffeting that more expensive shares are hit by.
As my regulars know, I measure the relative cheapness of a stock in a few ways, ranging from the simple to the more complex. For example, I like to look at the ratio of price to some measure of economic value, like earnings, sales, free cash, and the like. I like to see a company trading at a discount to both the overall market, and to its own history. I added to my Hasbro position earlier when the PE was sitting at around 22 times, and the market was paying $1.47 for $1 of sales. I was also attracted to the 4.24% dividend yield. Fast forward to the present, and the shares are either about the same price, or much more expensive per the following:
My regulars know that I think ratios can be instructive, but I also want to try to work out what the market is "thinking" about a given investment. If you read my stuff regularly, you know that the way I do this is by turning to the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply some pretty basic math to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit opaque, you might want to try "Expectations Investing" by Mauboussin and Rappaport. These two also have introduced the idea of using the stock price itself as a source of information, and we can infer what the market is currently "expecting" about the future. Applying this approach to Hasbro at the moment suggests the market is assuming that this company will grow earnings at a rate of ~3.25% in perpetuity. I consider that to be a slightly optimistic forecast, actually. Given the above, I'm not putting any more capital to work here. I'm not selling my Hasbro stake, but I'm not adding to it either.
For further details see:
Hasbro: I'm Neither Adding, Nor Selling