2023-10-03 13:26:20 ET
Summary
- Mattel's shares have risen about 14% in the past year, despite a downturn in its core toy business.
- The success of the Barbie movie has opened up new opportunities for Mattel to monetize its intellectual property.
- The company's cost-cutting measures and balance sheet improvements have made it more resilient and efficient.
- As it monetizes its intellectual property into more films, there is the potential for meaningful earnings growth while also boosting toy sales.
Shares of Mattel ( MAT ) have been a solid performer over the past year, rising about 14%. This comes as it navigates a downturn in its core toy business, which has weighed on results, but as new opportunities to monetize its intellectual property appear abundant after the blockbuster success of the Barbie movie. With toy spending likely near a bottom and potential upside from future film releases, I believe shares can go higher still.
In the company's second quarter , Mattel earned $0.10 in adjusted EPS, down from last year's $0.18. Note that these results are through June 30th, and Barbie did not open until July. Sales declined 12% to $1.09 billion. This was actually an improvement from Q1's 22% decline . Mattel has been hurt by retailers reducing their toy inventories, which had grown bloated in 2022. Mattel believes retailers' sales of its toys were down high-single digits, so MAT's sales to retailers underperformed by 300-500bp. In the long run, as inventories normalize, its sales and retailers' sales will follow the same trajectory. This sequential improvement points to the fact we are largely through the inventory destocking cycle.
Additionally, Mattel has been aggressive in working through its own inventory to right-size supply and regain pricing power. Over the past year, inventory has fallen from $1.18 billion to $972 million. With channel inventory improving, we should see sales continue to improve towards consumer demand levels.
Just given lower revenues, adjusted EBITDA declined to $148 million from $185 million. Notably, Mattel was able to keep gross margins flat at 44.9% thanks to a three-year cost-cutting program to improve efficiency. Along those lines, it reduced SG&A spending by $19 million (5.5%) to $343 million while holding advertising spending flat. In addition to reducing costs, Mattel has also shored up its balance sheet and has paid down $500 million of debt since 2017. With $2.33 billion of debt today, debt/EBITDA leverage should end the year at about 2.5x, a reasonable level.
These actions to reduce cost and de-lever the balance sheet have made Mattel a more efficient and resilient company able to weather industry downturns like the one we have seen weigh on results the past year. Even with lower sales, it has generated $361 million in free cash flow over the past year, thanks in large part to working capital optimization. For the full year, management had guided to adjusted EPS of $1.10-$1.20 and free cash flow of over $400 million.
Importantly, I see further evidence, beyond shrinking sales declines and lighter inventory levels, that the toy business is nearing a turn. Gross billings, an indicator of future revenue, declined by 11%, similar to this quarter's sales decline, but there is significant movement under the hood. Fisher-Price was down 28% to $164 million, and action figures were down nearly 40%, due to the timing of film releases. However, doll billings rose 10% to $441 million while vehicles rose 11% to $364 million. Hot Wheels is enjoying solid growth, driving the gains in vehicles. Notably, the strength in Dolls was due to Disney Princess with Barbie slightly declining. In Q2, no one knew how big the Barbie movie would be, and so orders for Barbie fell by 6%. This means upside for toy revenue from the film is not yet showing up in Mattel's numbers and can play a meaningful role in improving bookings and revenue trends.
At a macro level, the average American household spent $167 dollars on toys and hobbies in 2022 (about $17 billion). You can also see the decline in sales from 2021 to 2022 below, which in part has caused the inventory hangover Mattel and retailers have been working through this year. With sales declining high single-digits this year, spending will be about $150-155, the lowest level of the past 10 years, when adjusted for inflation.
Higher inflation squeezing real incomes has definitely forced consumers to cut back spending on some discretionary items, but at the current run-rate, real toy spending is probably about as low as it can get, given the last decade of data, barring a significant recession. Indeed if unemployment stays low, I would expect to see spending on toys gradually recover, toward historic averages, which would represent 7-9% upside.
Demographics have also hurt Mattel's infant/toddler sales, namely at its Fisher-Price brand. As you can see below, births fell sharply in 2020, according to the CDC . Fewer people born in 2020 means fewer 2-3-year-old toddlers today. However, births in 2021 and 2022 have been above 2020 levels meaning the toddler population should increase over the next two years, which would support some recovery in sales at this unit.
Overall, Mattel's toy business is likely at a cyclical bottom. Assuming we see sales stabilize at current levels before gradually rising low single-digits, the underlying business should be able to generate about $1-1.10 in earnings over the next twelve months.
Next, there is the film factor. Barbie has become an absolute phenomenon, grossing $1.4 billion dollars worldwide, the fourteenth biggest release of all time. Among the top 20 films, it joins Titanic and the Super Mario Bros. Movie as the only ones not to become part of a larger cinematic franchise - for now.
While no future release may be able to match the financial prowess and cultural zeitgeist of "Barbenheimer," you can be sure there will be efforts to continue this franchise, through direct sequels, spin-offs, either in film, TV, streaming or all the above. Mattel expects to see about $125 million in gross billings from the Barbie movie this year. This licensing revenue brings with it a hefty 60% operating margin. That provides about a 25% uplift from its trailing 12-month operating income of $300 million .
And that is from just one movie. There are over a dozen films potentially in the works, trying to capitalize on Mattel's vast array of intellectual property, from Thomas the Tank Engine to "Rock'em Sock'em." In 2025, Warner Bros. ( WBD ) will release a Hot Wheels film . Note above that Barbie's billings were falling into the movie's release whereas Hot Wheels is growing. Given the sustained success of the "Fast & Furious" franchise, the potential for a kids-oriented racing film franchise is significant.
Of course, not every Mattel franchise can be a successful film, and the execution of each may not be great. Certainly, no one expects Mattel to have a $1 billion film each year - not at the current stock's valuation at least.
With superhero fatigue a concern and Warner's DC film offerings struggling mightily , Hollywood is looking for ways to diversify content away from comic books, making this a particularly opportune time for Barbie's success. Studios need to find new content, and Mattel has just flexed its muscles. Coming on the heels of Super Mario Bros.'s theatrical success, it is clear that audiences are hungering for new content, and there may be a treasure trove of opportunities to creatively adapt toys and games into films.
While no film may generate the $100 million in profits Mattel may eventually receive from Barbie's release, by releasing several films a year, MAT could generate this much cash flow on an ongoing basis by licensing its brands. Moreover, by turning one-off films into franchises with releases every few years, or streaming shows churning out new seasons every year, these one-off surges can become a source of high-margin, recurring cash flow.
Further, there will be the downstream impact on the toy business by making these products more culturally relevant. Do we expect more children will want a Barbie toy this Christmas than last Christmas? That seems like a safe assumption to me. Similar to what Disney ( DIS ) has done, using films to create an ecosystem for consumer products and parks, Mattel can do the same for its toys (obviously on a much smaller scale). Maybe one day a theme park will boast a Barbieland, just as Universal ( CMCSA ) has a Harry Potter World. The future is unknowable, but the opportunities appear abundant.
Investors should look at Barbie, not just as a one-time windfall, but as the first step in creating a large-scale, high-margin licensing business for Mattel's existing intellectual property, one that I do not believe is fully priced into shares. The success of Barbie should help to generate another $0.20-$0.30 in EPS over the next year.
Given my baseline $1-$1.10 in earnings from its legacy business, assuming we see sales stay at current levels, MAT has ~$1.30 in earnings power. That is a 16.7x multiple for a company whose core business is running near cyclical bottom earnings and has a potentially lucrative licensing beginning that is just starting to shine, which I view as an attractive entry point.
Breaking the business conservatively in two, at a 15x multiple for its existing business & and a 25x multiple for the new $0.30 in licensing earnings, given its higher margin and growth potential as the film and TV slate gets fully up and running, shares would be $23.25-24. I still view this as conservative, given the fact strength in licensing should facilitate greater demand for toys. Moreover, with studios and tech companies looking for content to fill their streaming services and superheroes having lost some luster, M&A is a possibility. At just an $8 billion market cap, MAT is quite digestible, and there may be some CEO who looks at what Disney did to Marvel, taking a $4 billion purchase and creating a unit valued at over $50 billion , and wonder how much Mattel's IP could be worth if executed on properly. To be clear, I think this upside is much smaller than Marvel, but at $8 billion, the IP offers material upside from here.
At $22, you can essentially buy the toy business at 15x earnings and get the licensing operation at 20x. Given the potential optionality created by licensing out its IP, I think this is a compelling entry point. I see an upside through the next earnings release when investors will see the cash and earnings upside from the licensing unit begin to come to fruition. As toy sales recover and licensing grows, I believe MAT can be a multiyear growth story for investors and would be a buyer to at least $25 (16x through legacy EPS and 25x incremental licensing earnings), or 15% above current levels.
For further details see:
Mattel: More Barbie Upside To Come