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Has Mattel Finally Reached a Turning Point?

Leo Sun, The Motley Fool

Shares of Mattel (NASDAQ: MAT) recently soared after the company's second-quarter numbers beat Wall Street's expectations. The toy maker's revenue grew 2% annually (5% in constant currency terms) to $860 million, clearing estimates by $38 million. Its adjusted loss of $0.25 per share, which topped expectations by $0.14, also narrowed from a loss of $0.54 a year earlier.

That earnings beat was surprising -- Mattel spooked the bulls earlier this year with expectations for flat sales growth, historically weak margins, and soft earnings growth. So has Mattel's business finally reached a turning point? Let's dig deeper to find out.

A model dressed up like Barbie.

Image source: Getty Images.

The key facts and figures

Barbie and Hot Wheels were Mattel's core growth engines last year. The strength of those brands carried it through the Toys R' Us liquidation and offset the dismal sales of its Fisher-Price, Thomas & Friends, and American Girl products. But during Mattel's Toy Fair analyst day in February, CFO Joe Euteneuer warned that Barbie and Hot Wheels would generate "continued growth" but "not to the extent" of their gains in 2018.

Yet Barbie and Hot Wheels still fared well during the second quarter, generating 13% and 9% year-over-year constant currency gross sales growth, respectively, and remained the core growth engines of the company's dolls and vehicles businesses. Here's how those two units, along with Mattel's other two main segments, fared during the second quarter.

Segment

Q2 2019 gross sales*

Year-over-year growth
(reported)

Year-over-year growth
(constant currency)

Dolls

$273.4 million

3%

6%

Vehicles

$214.1 million

0%

3%

Infant, Toddler, and Preschool

$252.0 million

(13%)

(11%)

Action Figures, Building Sets, and Games

$222.7 million

21%

23%

Source: Mattel Q2 2019 report. *Excludes discounts, returns, and sales allowances (which are included in its net/reported sales).

In dolls, the strength of Barbie and Polly Pocket offset poor sales of American Girl and Enchantimal products. In vehicles, robust sales of Hot Wheels offset waning demand for Jurassic World and Cars vehicles.

Mattel's action figures, building sets, and games business became major growth engines during the quarter, thanks to initial sales of Disney's (NYSE: DIS) Toy Story 4 products. That warm reception bodes well for the recent expansion of its licensing deal with Pixar, which will allow Mattel to start selling products based on a wider range of Pixar franchises next May.

The Toy Story short film "Small Fry".

Image source: Pixar.

However, Mattel's infant, toddler, and preschool segment remained a sore spot as its Fisher-Price and Thomas & Friends brands continued to wither. Mattel attributed Fisher-Price's decline to the elimination of weaker licenses in its third-party licensing portfolio, but stated that its "core" business would improve in the second half of the year with new product launches and licensed Disney products for Toy Story 4 and Frozen.

As for Thomas & Friends, Mattel is simplifying its lineup of products and developing a new content and marketing strategy for the brand's 75th anniversary in 2020. It's still unclear if those turnaround efforts will pay off, however, since the infant, toddler, and preschool unit is a consistent underperformer, and that softness could persist as birth rates decline in developed countries.

Expanding margins and narrowing losses

Mattel's adjusted gross margin also expanded 950 basis points annually to 39.9%, fueled by a better mix of higher-margin toys and the company's ongoing "structural simplification" plans to eliminate outdated business units and streamline its operations. That improvement backs Mattel's prior forecast for expanding its gross margins into the low-40s this year.

Those improvements, along with tighter cost controls, narrowed Mattel's adjusted operating loss from $134 million a year ago to $30 million. Its adjusted EBITDA also turned positive at $42 million, versus a loss of $59 million a year earlier.

Mattel expects its full-year gross sales to stay flat in constant currency terms, with its recent recall of Fisher-Price's Rock 'n Play sleepers (following several infant deaths) offsetting some improvements at its other businesses. However, Mattel still expects its expanding margins to roughly double its adjusted EBITDA to $350 million to $400 million for the full year. It didn't provide any EPS guidance, but analysts still expect its adjusted EPS to stay in the red.

So is it time to buy Mattel?

Mattel's business isn't headed off a cliff, but it isn't ready to soar yet. The toy maker is barely offsetting the weakness of its laggards with the strength of its leaders, its gross margins remain historically low, and it doesn't have a clear path toward profitability yet.

If I wanted to invest in a toy maker, I'd stick with Hasbro, which has better revenue and earnings growth, or Funko, which dominates a growing niche of pop culture collectibles for older customers. Mattel still has too many soft spots to be considered a worthy buy.

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Leo Sun owns shares of Walt Disney. The Motley Fool owns shares of and recommends Hasbro and Walt Disney. The Motley Fool is short shares of Hasbro and has the following options: long January 2021 $60 calls on Walt Disney and short October 2019 $125 calls on Walt Disney. The Motley Fool has a disclosure policy.