MAT Adapting to Consumers

Mattel MAT continues to adapt to children’s demands, innovating new products tailored to changing tastes. With a number of new franchises coming on line in 2013 (including Ever After High and Max Steel), the company will maintain the wide brand recognition it has captured over numerous decades, keeping its narrow rating intact. While second-quarter results fell short of expectations,  the rest of the year will be business as usual, but Mattel risks falling slightly shy of its targeted 11%-13% earnings per share growth goal. The second half could more quickly leverage expenses as shipments become closer to sales, allowing for fewer marketing and promotional dollars spent versus prior years since more current products will be on the shelves at retail.

Shares are trading at $43 today, representing approximately 17 times 2013 estimated earnings per share, which is still somewhat lofty if long-term earnings per share growth in the low-double digits is expected. The second quarter represented a hiccup in a long string of successful quarters. The remainder of the year will fall in line with the company’s long-term financial goals, achieving gross margins above 50%, operating profit growth of 6%-8%, and top-third to top-quartile total shareholder returns.

Additionally, disciplined capital deployment remains at the forefront of management’s plans, as the company spent $125 million on dividends and $119 million on share repurchases in the quarter. The company continues to innovate, today announcing the launch of their newest franchise, Ever After High, about fairy tale legends that choose their own fate. The creation of new and innovative products to capture revenue from incremental segments of the children’s toy market is imperative in order for Mattel to continue to grow its top line at a mid-single-digit rate, and the creative team continues to deliver compelling ideas to do so.

Overall, the second quarter provided a mixed bag of results. Total sales rose only 1%, to $1.17 billion, with North American gross sales falling 1% and International gross sales rising 4%. Most of the core brands delivered a disappointing quarter, with Barbie sales falling 12%, Hot Wheels declining 1% and Fisher-Price (a brand the company has been trying to fix for some time now) shrinking 3% year over year. The strong core brand performance came from the American Girl brand, whose sales rose 14% year over year, to $78 million during the second quarter (and is on track to surpass $600 million for the full year).

Anecdotally, Mattel’s brands that have performed well in recent quarters continue to do so; Monster High, Thomas and Friends, and American Girl again led the pack. By geography, Mattel experienced relative strength similar to most other retailers, finding demand in emerging markets (Russia, Eastern Europe, Mexico, Brazil, China, and India mentioned specifically) and weakness in Southern Europe, which we are certain is attributable to the still-weak European consumer. Despite headwinds from input costs and currency translation, Mattel was able to maintain its gross margin rate year over year, at 51.3%, thanks to better pricing and mix. We note that this is in line with 2013 gross margin goals in the low to mid-50% range. The SG&A ratio experienced a significant increase, rising 320 basis points year over year to 33.5%, impacted by an impairment charge to the Polly Pocket brand, increased spend on strategic growth investments, and higher employee-related costs. Had this ratio been flat year over year, earnings per share would have been in line with consensus estimates.

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