2023-07-24 12:17:04 ET
Summary
- Mattel's shares are more expensive now than in January.
- Mattel's Q1 2023 revenue and net income were down by 22% and 596% respectively, with a net income loss of $106 million attributed to a drop in sales.
- Despite the company's financial struggles, some may consider buying back shares depending on earnings and if the risk is worth the potential returns.
It's been the better part of six months since I wrote my "hold" article on Mattel ( MAT ) with the very original title "Holding Mattel Ahead of Earnings." In that time, shares have risen about 5% against a gain of about 13% for the S&P 500. The company is about to release earnings, so I thought I'd review the name yet again. Additionally, I'm going to offer a forecast of what I think earnings will be. I'm going to compare that forecast to the current valuation to see if it makes sense to buy more, hold, or sell.
We're all busy people, and so I'm assuming you've got better things to do than read through a 1,600-word article. Add to that the fact that my writing can be a bit "tough to take," and the notion of wading through one of my pieces may be very tiresome indeed. Given that, I put a "thesis statement" near the front of each of my articles. You're welcome. This is a synopsis of my thinking, and offers slightly more than you can get from titles and bullet points. I'm going to be selling my stake in Mattel this morning. There are a few reasons for this. First, I forecast a loss before tax of about $94.5 million for the first half of this year, and that's troublesome, in my view. Additionally, the shares are actually more expensive now than they were in January, and the financial performance has been soft since then. This combination of mediocre financial performance and high valuation is a bad combination in my view, so I'm out until earnings are released. I may jump back in if I'm pleasantly surprised. I may miss out on some gains, but this is fine in my view, because I'm not seeking "returns." I'm seeking "risk adjusted returns," and in a world where my capital can find a home earning over 5%, I see no reason to risk it on the chance of a positive surprise. Finally, I haven't mentioned the "Barbie" movie in this piece because I consider its impact on this company and this brand to be "neutral to negative." I would be very surprised if that film drives sales meaningfully. Thus, the fact that Mattel itself apparently had significant control over the story here leaves me scratching my head.
So, I'm taking profits today, and may or may not buy back in after earnings depending on how things look for the next quarter.
Financial Snapshot
So far, 2023 has been a bad year for Mattel. Revenue and net income for the first quarter of the year were down by 22% and a whopping 596%, respectively. Revenue dropped by about $226 million, and net income swung from a $21.5 million profit to a $106 million loss. This loss can't be attributed to any one-time events, it all stemmed from the drop in sales.
On the bright side, the capital structure was somewhat de-risked, with long-term debt down about $245 million from the year ago period. I really like the fact that long-term debt is about 10% lower today than it was in the first quarter of 2022. I might hold out some hope that the company is back to 2016 levels of indebtedness. In my view, the capital structure remains quite strong here, with cash on the books representing about 12% of total liabilities. I don't anticipate any imminent financial problems here, especially given the current obligation schedule, per the following:
Mattel Inc. Financials (Mattel Inc. investor relations)
Predicting is Hard, Especially About the Future
Before getting into the forecast, I think it's worth keeping in mind that advertising, and "Other Selling" expenses are relatively fixed and don't vary much whether revenue is $2.3 billion, or $1.6 billion. On the other hand, "cost of sales" moves up and down with revenue, ranging from about 55% to 65% of revenue.
I'm going to assume that the trends established in the first quarter of this year will persist, namely that the top line is lower by about 22% from 2022. Given that the first half of 2022 saw revenue of about $2.277 billion, I'm forecasting sales of about $1.83 billion for the first six months of 2023. From there, I'm going to assume a consistency of expenses as a percentage of revenue. Based on the history here, I'm considering cost of sales to be a variable expense, and I'm assuming it's sitting at about 60% of revenue. "Other selling expenses" are similarly variable, at about 34% of revenue. Some expenses, like advertising, are pretty reliably fixed at about $155 million for the first two quarters. Additionally, I'm going to assume that interest expense for the first six months of 2023 will be simply double what it was during the first quarter. Obviously, this forecast is full of simplifying assumptions, but I think they're reasonable. I've noticed that even if I vary the forecast by reasonable amounts, 10% here, 15% there, the overall doesn't change sufficiently for me. Thus, I don't worry too much about the lack of precision here. This forecast isn't precise, but it's a forecast, upon which I'm going to base my investment decision.
Another way to think of my forecast is that it's a benchmark. It assumes a constancy that may not be evident in the very fuzzy data, and that's fine. The value of something like this is that it allows me to ask the question "given that many of these costs are fixed, by how much would Mattel sales need to rise above the current trend in order to make the company acceptably profitable?" Now, "acceptably profitable" is obviously subjective, so it varies from person to person. For me, the firm would need to generate sales of about $2.6 billion for the first two quarters of this year. Given that the first quarter saw revenue of $815 million, I'd need to see revenue of $1.785 billion in the upcoming quarter. Given what's been going on so far this year, I'm not holding my breath for that outcome. Thus, I'm not sanguine about the upcoming financial result. The market may react in an excited manner because of some scrap of good or bad news, but in my view, the firm is so far below where I need it such short-term perturbations would be noise, and thus not worth paying attention to.
Author Forecast of 6 Month Earnings (Mattel investor relations, author forecasts)
Given all of the above, though, I'd be happy to buy more at the right price.
The Stock
It's time for me to point out once again that I consider the stock and the company to be two very different things. The company sells toys, lifestyle products for children, games, and the like, and the stock is a piece of virtual paper that gets traded around a public marketplace, and it moves up and down based on the future expectations of the company. The relevant point to remember is that a great company can be a terrible investment at the wrong price, and a troubled business can be a decent investment if you buy it at the right price. Price really matters, therefore, hence the focus on the stock.
For those who need me to beat the proverbial dead horse, allow me to drive the point home further by using Mattel stock itself as an example. Let's imagine an investor bought these shares on Feb. 3 of this year. They're up about 1.6% on their investment since. Let's imagine another investor bought virtually identical shares about 40 days later on March 15. That person is up about 35% on their investment. Not enough changed at the company to justify a 33% variance in returns over such a short period of time. The price paid was the most important variable in determining the returns for these two very real pair of investors. The one who bought the shares most cheaply did best, which is why I always like to buy shares cheaply.
I measure the cheapness of shares in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, like sales, earnings, free cash flow, and the like. I want to see a stock trading at a discount to both the overall market and its own history. In the previous missive, I was happy that the shares were trading very near multi-year low valuations on a price to sales basis. Specifically, the PS ratio was 1.252 previously. The shares also sported a PE of about 12 times. Obviously, that's no longer a relevant metric, so I'll have a look at the price to free cash flow measure instead. This is the current state of the world:
Source: YCharts
Source: YCharts
The market has bid up these shares by about 19% on a price to sales basis. Additionally, the shares are trading at about 42 times free cash flow. This is too rich in my view.
Given my forecast of a sclerotic financial result, and the fact that the market is a bit optimistic at the moment, I'm going to take profits here. I may buy back depending on how the earnings shake out, and I may miss out on some upside by selling today. I'm comfortable with that, though, because I'm not seeking "returns." I'm seeking "risk adjusted returns," and the risk just isn't worth the upside here.
For further details see:
Selling Mattel Ahead Of Earnings