Mattel – Steady, But Not On Sale

By Stephen D. Simpson, CFA | October 13, 2011 AAA

There are not too many companies out there that sell products that have been popular across multiple generations, but Mattel (Nasdaq:MAT) is one of them. In many respects, Mattel looks like an excellent company - it offers beloved brands, a strong return on capital and respectable margins. The question for shareholders, though, is whether management is willing to take the sort of risks that will be necessary to really improve growth, and make this more than a steady dividend play.

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Solid Third Quarter Results
On the whole, Mattel delivered neither a positive surprise nor a disappointment for the third quarter. Revenue rose about 9% as reported, with 7% growth when measured in constant currency. Domestic growth was a bit softer than international (6% versus 8%), but balanced all the same. Although the company's Fisher-Price business saw a little revenue erosion on a constant currency basis, the Barbie franchise saw 13% growth.

However, Mattel did do surprisingly well with its margins. Gross margin fell more than three full points, with almost half of the impact coming from foreign currency. Still, given what is going on in packaging, resins and other inputs, Mattel is managing its cost structure quite well. Mattel also posted nearly 11% growth in operating income as the company continues to do a very good job of managing internal expenses.

Waiting for the New, New Thing
While this quarter's performance, from the Barbie line, would suggest that the company can still produce its own growth, a lot of the upside seems to come from licensed properties. A strong relationship with Disney (NYSE:DIS) has produced a steady stream of winners, but the movie tie-in business is notoriously unpredictable. Time Warner's (NYSE:TWX) next "Batman" movie should be a slam-dunk for merchandising, but the "Green Lantern" was a surprising flop.

Mattel is trying to build new brands, but it takes time. Maybe Monster High can be the next Barbie or Hot Wheels, but the odds aren't very good. Consequently, investors have to make their peace with a business model that is balanced between slow-and-steady multi-generation brands and hit-or-miss licensed tie-ins. Making matters worse, Hasbro (Nasdaq:HAS) and Jakks Pacific (Nasdaq:JAKK) are always out there looking for their own deals, so it's not as though Mattel has the pick of the litter whenever it pleases.

Too Conservative for Its Own Good?
Mattel management deserves a lot of praise for how it runs this business. When it comes to "blocking and tackling" functions like reducing overhead, controlling production costs and ironing out distribution snags, Mattel generally does well and the returns on capital show it.

Where Mattel may have a longer-term problem, though, is in its risk appetite. Mattel's acquisition of The Learning Company was an unmitigated disaster, and the company has seemed to shy away from big moves since then. The risk, then, is that the company plays its cards too close to the vest and lets growth opportunities slip away.

Why does this matter? Well, the Bratz line of dolls did some real damage to Mattel, before it was able to score some victories in court on the basis of contract exclusivity with the doll's designer. Winning in court is not the same as winning in the market, and Mattel can't just rest on its laurels and assume its classic line-up will stay popular.

The Bottom Line
For the most part, the risks that Mattel faces are known by the Street - risks that tie-ins will flop, risks that products may be unsafe and require recall and risks that new, hot products draw away consumer dollars. Mattel has been in business long enough, though, that most investors are likely not too bothered by any of those issues.

The question for shareholders is whether there's enough growth left in this business to validate a purchase. The dividend looks safe and Mattel looks like a company that can grind on through the good and bad times. But, is Wall Street willing to pay for that quality and reliability? Absent the ability to drive better growth, this is a decent hold but not a very compelling buy. (For additional reading, take a look at How Companies Create A Brand.)

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