Has Mattel Lost the Toy Wars?

Mattel's lackluster growth might stoke fears that traditional toys and games are going the way of the buggy whip. Here's why the panic is overblown.

Feb 22, 2014 at 7:30AM

Toy giant Mattel (NASDAQ:MAT) had a tepid year in 2013. Its weak performance was startling, especially considering that the consumer landscape was shaping up in the company's favor heading into the crucial holiday shopping season. Consumer-oriented economic data, including sentiment and spending, held up fairly well in the fourth quarter. And yet, Mattel barely grew last year.

It's reasonable to question whether this is a Mattel-specific problem. However, close rival Hasbro (NASDAQ:HAS) struggled last year as well, so there are legitimate concerns about whether toys more broadly are losing momentum with consumers. Mattel management promises better performance in the year ahead, but if consumers are turning away from traditional toys and games and toward electronic games, the company may be stuck between a rock and a hard place.

The 2013 toy story didn't end well
Mattel's net sales inched up 1% last year despite a 6% drop in sales in the fourth quarter, which is by far the most important period for toy makers like Mattel and Hasbro. Mattel expanded its gross margin by 50 basis points last year due to cost reductions. That allowed the company to produce 4.5% earnings-per-share growth.

Hasbro's results painted a similar picture. Hasbro generated flat revenue in 2013 along with earnings per share that were only fractionally higher after stripping out various one-time items, such as restructuring expenses.

Mattel's and Hasbro's results reveal a striking disparity in performance across geographic regions. Both companies continue to do fairly well internationally, particularly in the emerging markets. Mattel posted 5% sales growth in its international operations but saw North American sales fall by 2%. Likewise, Hasbro's international sales increased 5% last year, but its U.S. and Canada segment experienced an equal 5% drop in sales.

What's driving weak U.S. performance?
One possible explanation could be that consumers in the United States are getting an increasing share of entertainment from electronic games. After all, the boom in the smartphone industry has resulted in widespread adoption of mobile entertainment. However, it's worth noting that electronic-game developer Zynga (NASDAQ:ZNGA), which makes games for mobile devices, including Words With Friends and FarmVille, struggled right alongside Mattel and Hasbro last year.

Zynga saw its sales fall to $873 million last year, down from $1.2 billion in 2012. In percentage terms, Zynga's revenue collapsed by 32% in 2013. The major reason for this performance is that users are fleeing. Zynga's monthly unique payers totaled 1.3 million in the fourth quarter, which was less than half the 2.9 million from the year-ago quarter. It's true that average daily payments per active user rose 10% versus the third quarter. However, what this implies is that those users who really love Zynga's games stick around, but most users don't seem to fall into that category.

Bottom line: Don't panic over Mattel's results
It's easy to succumb to the panic that traditional toys and games will amount to buggy-whip technology that is eradicated by mobile entertainment and social media games. However, this is not what seems to be happening. Mattel and Hasbro both had lackluster performance last year in the U.S. and Canada, but they both still managed earnings growth thanks to strong performance abroad. And Mattel did generate revenue growth last year as well.

It seems that Mattel and Hasbro simply failed to execute in the United States. The retailing landscape in the fourth quarter turned extremely difficult, driven by harsh winter weather conditions that put a serious dent in retail sales. Mattel and Hasbro are doing very well in the international markets, and their strong brand connection with North American consumers will allow them to improve their performance in short order.

In the meantime, investors can enjoy their outsize dividend yields. Mattel and Hasbro both increased their dividends after releasing full-year results, and in Mattel's case, its 4.2% yield and modest valuation look particularly attractive.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends and owns shares of 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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