2023-05-23 18:18:58 ET
Summary
- 1Q23 revenue and adjusted EBITDA surpassed expectations, driven by favorable shipment timing and positive inventory turnovers.
- MAT is making progress in addressing the inventory issue that has been impacting profits.
- Despite the recovery in valuation multiples, MAT's forward EBITDA valuation remains attractive.
Investment thesis
The 1Q23 results show that Mattel ( MAT ) has the ability to continue executing and returning capital to shareholders. Both revenue and adjusted EBITDA were better than expected. The performance was largely driven by the timing of shipments, which pulled forward 2Q revenue into 1Q. In addition, management restated their FY23 projections that were provided in February, which aids in reducing risk to consensus FY23 numbers. Management also pointed to positive inventory turnovers and point-of-sale ((POS)) trends as evidence that MAT is expanding its market share internationally across its core product lines. This, in my opinion, is proof positive that management is successfully executing its organic growth plans. As for inventories, I believe we are finally going to see the end of it as retail inventory levels, which had been high coming into 2023, saw improvement in 1Q, and were forecast to normalize by the end of 1H23, according to the company's management. In light of the 1Q23 performance and updates so far, I continue to see MAT as an attractive investment target (buy rating). So far, the stock has done pretty well against my expectations, which suggests that the market is slowly waking up to MAT's true value - which I expect to further crystalize as management continues to execute.
Inventory issue
Now that MAT has to get rid of seasonal inventory, the light at the end of the tunnel is in sight for the "inventory issue" that has been a major drag on profits. On the call, management highlighted the fact that 1Q23 retail inventory levels were better than 1Q22 levels in both dollar value and weeks of supply. To put things into perspective, in comparison to the 15% y/y increase seen in 4Q22, the current value of inventories is down 1% from this time last year. That said, while retailers are making adjustments, the slight increase in inventory levels is expected to weigh on 2Q gross billings. Importantly, management confirmed that they are making progress in reducing retail inventory and anticipate resolving the issue by 1H23. They also expect shipping patterns to return to their usual historical trends in the 2H23. With the easing of inventory issues, I believe we could see LTM gross margin recover back to historical levels (high-40%), a 200-300bps increase from the current level. This 500 bps would have a huge increase to the net income figure given the high incremental margin. To give further context, if LTM gross margin is at 48% today, I believe it would be a 36% increase to its EBIT figure - clearly demonstrating the asymmetrical impact of a 200-300bps increase in gross margin.
Capital allocation
The second key issue that I monitored was MAT's capital allocation strategy. It was encouraging to see management maintain its capital allocation policy - with a primary target to reinvest for organic growth. Its leverage ratio is also expected to move towards 2 to 2.5x, which I think is easily doable in FY23 (consensus is already expecting this to drop into the 1x+ range). As such, I do not see any issue with liquidity for the business. Importantly, management has stated that share repurchases will continue in 2023 and disclosed that the company has $169M available for share repurchases in 2023 (though no specified amount was mentioned for the 2023 repurchase).
Valuation
MAT's valuation on a forward EBITDA basis still remains attractive at 8.5x, despite the recovery since the low of ~6.7x. I believe the recovery in multiples is a testament to the market giving credit to the MAT recovery story and the issues it had previously (e.g., inventory) are soon to be over. Looking ahead, MAT has only 1 goal, and that is to meet its own guidance - which I believe would help push valuation further higher as investors would look to ride on this "proven" recovery story. The returns here could be very attractive if earnings grew along with a positive rerating of multiples. If we assume consensus EBITDA estimates are correct, MAT will generate $1.1 billion of EBITDA in FY25. If multiples revert to their historical mean over the past decade (11.5x), the upside is pretty significant.
Own model
Risks
Despite a strong execution and recovery story, there are two risks to be aware of here. To begin with, if we enter a deep recession, MAT will be hit hard because weak consumer spending will lead to a drop in underlying toy demand. Second, if MAT fails to properly align its product portfolio, there may be cannibalization of Doll growth due to increased competition from other product franchises, which management has so far been good at. Mistakes in execution would be disastrous in this case, as management is working hard to regain the trust of the investment community.
Conclusion
Based on the 1Q23 results and the progress made by MAT in executing its growth plans, I maintain a positive outlook and recommend a buy rating for the company. Importantly, management's reaffirmation of their FY23 projections further reduces the risk to consensus estimates, in my view. The ongoing efforts to address the inventory issue are also yielding positive results, with inventory levels improving and expected to normalize by the end of the first half of 2023. This improvement in inventory, along with expected shipping patterns reverting to historical trends in the second half of 2023, positions MAT for a recovery in gross margins. The company's capital allocation strategy also remains intact, with plans for continued share repurchases in 2023. Lastly, the current valuation is still appealing, and meeting guidance could lead to a positive rerating of multiples, resulting in significant upside potential for investors.
For further details see:
Mattel: Execution Continues To Be On Point