Streetwise for Sunday, December 2, 2018

This is the holiday shopping season so let’s talk toys. Although the toy space is lucrative, being a $100 billion industry worldwide, it is also a very challenging.

Seasonality lives here at the extreme. Technological change is accelerating. Licenses account for more than 30 percent of all sales and are driven by big screen movies watched by capricious kids.

One of the key players in the arena of toys is Hasbro (HAS). Unfortunately, Hasbro’s sales fell almost 12 percent in the third quarter due to the closing of Toys”R”Us. Although sales performance did not meet consensus expectations, the Street did not anticipate the extent of revenue damage resulting from the closure of Toys”R”Us.

Hasbro’s bad debt expense due to Toys”R”Us was $18 million, all of which was recorded in the third quarter. In addition, some existing products like Princess and Star Wars, did not fare well due to a lack of related movie screenings and content support.

Efforts to restore Hasbro to its previous glory will not be easy. New retailers will have to be partnered to create new channels of distribution. And Toys”R”Us had a different ordering pattern than most other retailers.

While Toys”R”Us would order large amounts of inventory months in advance, existing retailers order in small quantities and just before the holiday season begins.

Nonetheless, Hasbro has recovered one-third of its lost US and Canadian revenue. It has also announced plans to reduce its workforce creating $40 million of annual savings with a restructuring charge of $50-60 million.

One key concern is tariffs. Currently 85 percent of all toys sold in the United States are manufactured in China. Tariffs translate into higher costs that will likely be passed on to consumers.

Both Disney’s Princess and Star Wars will be supported by movie releases next year. Power Rangers and Overwatch themed products will be introduced. The goal is revenue growth of 10 percent year-over-year with a profit margin expansion of about 15 percent in 2019.

New Spiderman and Bumblebee movies to be released in the fourth quarter should improve the company’s revenue posture short-term, while supporting sales of related brands and products.

Franchise brands and Gaming segments continued to perform well. Revenue for gaming was at $281 million, whereas consensus estimate was $261 million. Gaming revenue growth was in double-digits. Play-Doh showed growth for the first time in seven quarters while other products like Monopoly and Baby Alive continued to perform.

Partner Brands saw lower revenue during the third quarter. The new content coming online should reverse that situation. Hasbro has also made substantial investments in the digital gameplay platform.

The focus going forward will be on how soon Hasbro can start bringing in other retailers and conducting sales through those newer channel partners to recapture lost business.

At the same time, consumer preferences, especially those of children, are constantly evolving. Relevancy plays a major role and is difficult to project. Digital/experiential toys are the future. Any disruption in this area would become a major risk to Hasbro’s future.

Given the product pipeline, gaming and entertainment segment performance, and content support from upcoming movie releases, the longer-term Hasbro thesis is intact.

Moreover, Hasbro shipped its largest domestic dollar volume ever this past September. That month also saw Hasbro announce it had formed a partnership with Epic Games to introduce a variety of products specific to the popular game Fortnite. The collaboration allows Hasbro to ride on the coattails of that game’s extreme popularity.

The company’s shares recently closed at $95.60. The intrinsic value of the shares using a free cash flow to the firm model is $133.82. My earnings estimate for 2019 is $5.00 per share, with a projected 12-month share price of $106 for a 10 percent capital gain. There is also an indicated dividend of percent. The company has been raising dividends for 14 years with a 10-year dividend growth rate of 13.99 percent.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.