Why Wall Street is What's Wrong with Hasbro

At first glance, you'd probably assume Hasbro (NASDAQ: HAS  ) is doing poorly. After all, shares of the toy maker slumped 3% after reporting second-quarter earnings. The financial media didn't have many good things to say about Hasbro's performance, saying that the company missed estimates on revenue and posted declining profits.

But underneath the surface, a different image emerges. Hasbro didn't perform nearly as badly as its share price performance suggests. It did much better this quarter than rival Mattel's (NASDAQ: MAT  ) .

And yet, Hasbro's share price sank anyway. The reason might be that once again, unreasonable analyst expectations, and a misguided desire on the part of management to keep up with these expectations, are to blame.

Fortunately, its problems can be easily solved by tinkering with its capital allocation priorities.

Hasbro's second quarter, by the numbers
Overall, Hasbro's revenue grew 8% in the second quarter. This was an acceleration from last quarter's measly 2% sales growth, and far better than Mattel's 9% second-quarter sales decline.

Hasbro's net earnings dipped 7%, but that was mostly due to an unfavorable tax charge that shaved $0.10 off profits. Excluding this adjustment as well as a $2.5 million pension settlement charge that weighed down the comparison period, Hasbro's core operating profits increased 24%.

The biggest contributor from a product standpoint was Hasbro's boys category, thanks to robust performance of Transformers and Marvel products. In all, the boys segment posted 32% revenue growth, which more than made up for the 12% drop in sales of games, which is Hasbro's second-biggest category.

Among its major geographies, Hasbro is hurting in the United States and Canada. Sales fell in these markets by 2%. Fortunately, Hasbro is hitting it out of the park in the emerging markets. The company realized double-digit growth in Europe, Latin America and Asia, which resulted in 17% revenue growth in international markets.

And yet, Hasbro shares sold off after reporting results. Here's why.

Why Wall Street is to blame
What's happening to Hasbro is all-too-common in the stock market. As a company's share price gains momentum, as Hasbro's did after reporting first-quarter earnings, analysts try to one-up each other's estimates for future quarters, to try to convince investors that they didn't miss the company's improving performance.

The problem with this is the inevitable snow-ball effect. As analyst estimates go up, a company's stock price usually feeds off that and keeps grinding higher. Sooner or later, this builds unreasonable expectations on a company. That has the potential to bring a company back down, even if it reports earnings that are actually quite good.

In Hasbro's case, the stock was bid up to 21 times trailing earnings and 15 times forward earnings. This valuation level was perhaps too aggressive, since Hasbro produced flat revenue and less than 1% earnings growth last year.

Hasbro's flawed spending priorities
Hasbro is spending a lot of money on share repurchases. Unfortunately, its lofty valuation has blunted the impact of Hasbro's aggressive share repurchase program, which is where the company utilizes the bulk of its cash flow. Over the first half of the year, Hasbro repurchased 4 million shares of its own stock at an average price of $54.17 per share. This has cost the company $216 million, which looks like a foolish use of cash since the share price now sits at $51 per share.

Hasbro's balance sheet has deteriorated over the past year as it aggressively deploys cash. Its cash and cash equivalents fell from $1.02 billion one year ago to $586 million at the end of last quarter.

Meanwhile, the number of Hasbro's diluted shares outstanding has barely declined, despite all the cash spent on share repurchases. The company has only reduced its share count by less than 1% over the past year.

Instead of using such large amounts of cash on buying back stock to keep its valuation afloat, allocating that cash on its key strategic initiatives to restore growth, or holding onto more of the cash to improve the balance sheet, might be better alternatives.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3037276, ~/Articles/ArticleHandler.aspx, 9/1/2015 10:32:37 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Bob Ciura

Bob Ciura, MBA, has written for The Motley Fool since 2012. I focus on energy, consumer goods, and technology. I look for growth at a reasonable price, with a particular fondness for market-beating dividend yields.

Today's Market

updated 1 hour ago Sponsored by:
DOW 16,058.35 -469.68 -2.84%
S&P 500 1,913.85 -58.33 -2.96%
NASD 4,636.11 -140.40 -2.94%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/1/2015 3:59 PM
HAS $72.52 Down -2.07 -2.78%
Hasbro CAPS Rating: ****
MAT $22.57 Down -0.86 -3.67%
Mattel CAPS Rating: ****