Why American Girl Rocks Retail

Mattel (NASDAQ: MAT  )  reported better-than-expected third-quarter earnings, beating on both the top and bottom line, but its star was American Girl. Sales rose 20%, offsetting declining Hot Wheels and Fisher Price sales. 

A marketing marvel
Last week, the American Girl catalog arrived -- 72 pages of slick, glossy dolls and accessories. A Victoria's Secret catalog isn't photographed any more lovingly, and the descriptions of each item are masterpieces of copywriting.

Mattel has created a scarcity mind-set as the company 'retires' dolls like the popular Molly and Saige, only available for a limited time. Saige, the 2013 American Girl of the Year, helped drive sales of the American Girl division to $122.3 million for the quarter.

Not only is there every possible accessory one could dream of, but every race, disability, hobby, economic status, and ethnicity is represented in an American Girl doll. One accessory that bears mentioning is the allergy-free lunch kit with pretend food, medical alert bracelet, and anaphylactic shock faux hypodermic needle for $28.

The catalog also features matching outfits for the doll and her little girl. There are reproduction period furniture sets and a mini baby grand piano. Girls can also order an individualized doll to look like themselves.

One can buy a doll-sized 1974 Volkswagen Beetle, just like the first car I ever owned, for her 1974 era Julie Allbright doll, for only $350 dollars. I think that's what I paid for that car used, back in the day.

At 16 brick-and-mortar American Girl stores (located in high-end malls) girls can make an appointment with a personal shopper. These stores are destination shops for little girls with bistros, party rooms, doll hair styling, classes, and workshops.

Of the four core Mattel brands, Hot Wheels was down 2% and Fisher-Price was flat. Only Barbie, girl brands Monster High and Disney Princess, and American Girl showed sales growth in the third quarter. These last four together are the best-selling doll brands worldwide.

Mattel CEO Bryan Stockton said on the third quarter call,

We don't talk a lot about American Girl, but we sure love it. It's a $600 million business. It's growing strong double-digits. We have another store opening in Palo Alto [Calif.] here in a few weeks. And the growth in that brand is strong across the portfolio, whether it's portfolio of dolls or portfolio of locations or portfolio of channels.

Meanwhile, boy brand sales have been so sluggish that Mattel is teaching mommy bloggers how to play with Hot Wheels to encourage moms to purchase for their boys. The company has also developed a mobile app so when a mom shops she can tell if a Hot Wheel is already owned.

This holiday season is looking better for Mattel's under-performing core brands with 80 toys listed among the hot sellers on holiday toy lists from Kohl's, KMart, and Amazon.

The fundamentals of fun
Mattel is a five star CAPS-rated stock with a 3.3% yield and trading at a trailing earnings multiple of 18.4. Five-year sales growth has been anemic at 2.7%, and the net profit margin comes in at 12.7%.

Even while Mattel's stock has under-performed the S&P 500 index, rival toy maker Hasbro (NASDAQ: HAS  ) has surged 40% this last year. This is despite a lower five-year sales growth rate of 0.4% and a lower net profit margin of 8.6%.

Hasbro's five-year revenue growth and earnings-per-share growth rates at 0.4% and 4.7%, respectively, aren't impressive either--not compared with Mattel's revenue growth of 2.7% and EPS growth of 16.1%. It offers a similar yield to Mattel at 3.2% with a 19.3 trailing earnings multiple.

In the past Hasbro had seen strength in its boy brands, especially GI Joe, Transformers, Star Wars, and Marvel action figures, thanks to motion picture tie-ins. However, revenue declined 17% for boys and 2% for preschool when Hasbro reported its third quarter earnings, with girls and games much stronger. In fact American Girl, Hasbro's girls brands, Furby and My Little Pony combined helped revenue surge 29% for Hasbro Girl.

Weaker rival toy maker JAKKS Pacific (NASDAQ: JAKK  ) had been beset by lawsuits and declining revenue. Until it surprised on its third-quarter earnings, the stock was down 62% over the last year, and is now only down 50%. However, guiding for a full-year 2013 $2.56 EPS loss versus expectation of a $2.74 EPS loss is no reason to get into the stock.

The company is still struggling. In July, it issued $100 million of 4.25% senior convertible notes due 2018, and a repurchase of $61 million of convertible notes due in 2014 resulted in an increase of 7.2 million outstanding diluted shares. The company started restructuring in the second half, resulting in a decline in third quarter SG&A expenses of $51 million and 16.6% of net sales, from $59.4 million and 18.9% of sales in the third quarter of 2012.

Although Jakks Pacific Disney Princess line is performing well, with an upcoming launch for Disney's Frozen movie tie-ins as well as for PBS' Daniel the Tiger and Disney's Sofia the First, the company does not have an all-encompassing blockbuster line like Mattel's American Girl.

The Foolish takeaway
Boy brands are declining across the board for toy makers. Girls rule, and Mattel has the best girls' franchises. If Mattel were to expand American Girl internationally, I could easily see triple-digit gains for that division. With four strong doll brands and the holiday season looking better for Mattel, it isn't too late to buy shares. 

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