1 Toy Company to Buy Today

Toy manufacturer Mattel (Nasdaq: MAT  ) released third-quarter earnings, and things look excellent. The company increased sales and cut costs, helping push the stock up in early trading. Mattel has had a good run in 2012, and has managed to overcome a weak first quarter, which temporarily pushed the stock down. Here's a breakdown of the earnings, the competition, and the future of Mattel.

The third quarter
Mattel reported strong sales increases across its major divisions, except in its Barbie line. Mattel blamed the strong U.S. dollar and competition abroad for the 4% decline in revenue from Barbie. But the setback was minor, and overall revenue grew 4%. It was pushed up by strong sales from Fisher-Price, American Girl dolls, and its frustratingly popular Monster High dolls.

On top of strong revenue growth, Mattel also managed to push down its costs, with cost of sales falling 8%. The combination skyrocketed the company's operating margin from 20% in 2011 to 24% this year. Earnings per share grew 21%, and yet management held off on updating full-year guidance. In part, CEO Bryan Stockton is hesitant to count his chickens before the holiday season is hatched. Last year, the fourth quarter accounted for 34% of revenue and an impressive 48% of net income.

Unsurprisingly, the quarter's earnings beat out analyst estimates. It also got everyone's hopes up for a strong Christmas. Last year's fourth-quarter earnings were flat against 2010, but investors responded positively nonetheless. This year, with the reduced costs seen in the third quarter, investors are hopeful that the holidays will come with a gift of increased earnings.

The competition
Mattel's biggest direct competitor is the much smaller Hasbro (Nasdaq: HAS  ) , which reports quarterly results next week. On Monday, Goldman Sachs (NYSE: GS  ) downgraded Hasbro on fears that the toy market in general is slowing down, and that Hasbro is at risk going into the holiday season. Last quarter, Hasbro posted a disappointing 11% fall in revenue, mainly because of the weakness of its licensed merchandise. Sales of Marvel and Battleship merchandise didn't stack up against 2011's Transformers sales. In terms of size, Hasbro generated $4.3 billion in sales last year, while Mattel did $6.3 billion.

In a distant third place, JAKKS Pacific (Nasdaq: JAKK  ) will also announce third-quarter results next week. JAKKS lacks the strong stand-alone brands that Mattel and Hasbro tout, but has many strong licensing deals, including agreements with Nickelodeon and Warner Bros. Last year, JAKKS had $678 million in sales, and while the stock surged in spring this year, it has since fallen back after talks with Oaktree Capital fell through. The company lowered earnings guidance at the end of September.

The future
Mattel is the clear leader in the toy race and should take the lion's share of sales over this holiday season. The concern for investors is that even as Mattel eats the most pie, the pie might be shrinking. Goldman Sachs noted that, "The nominal amount spent on traditional toys/games in the U.S. per capita is down 30 percent from $85 per person to $60 per person since 1998, and the pace of the decline has accelerated to 5 percent to 10 percent year to date."

One of the main pressures comes from digital content producers like video game developer Electronic Arts (Nasdaq: EA  ) . EA has worked with Hasbro to develop digital versions of Milton Bradley and Parker Brothers games, but Hasbro is now competing with popular games like Angry Birds and The Sims for the attention spans of children. As tablets become more popular and digital content delivery becomes more advanced, toy manufactures are going to face a shift in consumer attitudes that could leave them behind.

The bottom line
Even though Mattel may eventually be pushed around by the video game industry, that point hasn't come yet. Goldman Sachs is bearish on the whole toy industry, but the progress that Mattel has made in cutting production costs and in expanding its sales shows that it's still a great company. I think naysayers are going to be proven wrong this year, and I'm optimistic about Mattel's ability to react to digital pressure in the future.

For a glimpse at three other strong companies to watch over the holidays, check out the Fool's report: "3 Companies Ready to Rule Retail." The fourth quarter is going to be big for all of them, and we think they're all going to come out on top. You can download your free copy today by clicking here.

Fool contributor Andrew Marder has no positions in the stocks mentioned above. The Motley Fool owns shares of Hasbro and Mattel. Motley Fool newsletter services recommend Goldman Sachs Group, Hasbro, and Mattel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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