After its fifth toy recall in six months earlier this month, Mattel (NYSE: MAT ) has investors wondering whether the top toymaker has its holiday calendar confused. While it seems a trick worthier of Halloween than a gift-wrapped present for Christmas, Mattel may finally have its defective toy issues behind it. No, really.
It's no secret the toy industry has been reeling from the spate of product recalls this year: 2007 was a summer marked by lead-tainted toys, defective dolls, and club-drug infused playthings.
Heading that list was a seemingly endless story of Mattel toys, but that has as much to do with its market-leading size as with the quality of its products. The biggest toymaker is bound to have more headline-grabbing recalls than other manufacturers.
Play it again, Sam
So why should investors think that Mattel has its act together now? If it's still recalling toys months after the crisis hit a crescendo, and it highly publicized the steps it took to correct the problems, should investors bet their money on it not happening again?
Nearly a month to go to Christmas, and the media still reports on what toys are not safe to buy instead of what the hot products are. More recalls may dent the stock more, which is already trading one-third lower than its 52-week high.
Yet there are reasons to believe the worst is behind Mattel and other toymakers. China has shut down hundreds of toy companies because of safety violations and has arrested more than 700 individuals for violating food and product safety guidelines.
In one of the most notorious incidents to illustrate China is becoming serious about its declining reputation, it executed an agency head for taking bribes, an act that had resulted in tainted products entering the market.
Nor are toymakers waiting for China to do all the work. They're establishing high-profile testing procedures themselves. Disney (NYSE: DIS ) , Wal-Mart (NYSE: WMT ) , and Target (NYSE: TGT ) are engaging in secondary rounds of testing to confirm the safety of the toys they sell.
Mattel instituted a comprehensive, multi-pronged approach to testing its toys, and because of the new test procedures, it caught additional problem toys. It shows Mattel's response to the recalls is working.
A closer look at how the market is valuing the company, however, suggests it may be an attractively priced stock right now.
Charging through the recalls
Mattel took a $40 million charge in the latest quarter for the recalls, which when added back in, allows it to have met analyst expectations of $0.70 per share in earnings. Sales abroad received a friendly boost from currency exchange rates and account for almost half of total revenues. That should serve to support Mattel's business until the domestic picture improves.
Further, where my Foolish colleague Rick Munarriz sees Mattel's die-cast Matchbox and Hot Wheels continuing popularity as a sign that the toymaker has problems, for me the fact that they still posted double-digit gains in the quarter means the lead issue is a transitory one.
Mattel trades at 14 times current year earnings and less than 12 times next year's, slightly lower on both counts than either Hasbro (NYSE: HAS ) or RC2 (Nasdaq: RCRC ) , and its $0.65 annual dividend (soon to be $0.75) is yielding 3.2%, which is a pretty nice payment for investors to receive while waiting for the market to digest how this toy story plays out.
This Christmas may indeed be blue, despite the cheery smile Mattel puts on the situation, but long-term the toymaker will find its diverse product line holding up. It's tough to predict whether Mattel will deliver to shareholders a stocking stuffer or a lump of coal this year. But as long as the company can have a "recall-free" holiday, shareholders may ring in a happy new year after all.