Why Mattel's Recovery Might Be Just Around the Corner

Mattel is still reeling from the effects of a poor holiday season last year. But it's working through its challenges and is investing in new products that should pave the way for better performance up ahead.

Jul 22, 2014 at 3:43PM

It might seem like a lame excuse to blame a company's poor first half of the year performance on what happened at the end of last year. But in the case of toy maker Mattel (NASDAQ:MAT), what happened during the holiday season last year tells the story of what's happening today.

In Mattel's case, the ripple effects of its poor fourth-quarter performance are still being felt. The fourth quarter encapsulates the holiday shopping season, which is critical for Mattel because that's the most important driver of full-year results.

But Mattel's struggles are likely to be short term, and it's steadily working through many of its operating issues that are currently weighing it down. It also has a viable growth strategy considering it's investing in new product categories, and it announced an interesting partnership with Amazon.com (NASDAQ:AMZN).

That's why, assuming it gets its act together, Mattel's beaten down stock looks like a great value buy.

No Christmas in July
If a toy company whiffs on a holiday season, as Mattel did last year, this often continues to weigh on the company well into the following year. That's exactly what's happening to Mattel, and it's the reason why Mattel has performed so poorly this year.

Mattel's second-quarter earnings report was unimpressive to say the least. Worldwide net sales fell 9%, due mostly to its flagship Barbie brand, which posted a 15% revenue decline.

But Mattel's first-half performance doesn't matter nearly as much as what happens in the back half of the year. Mattel's first two quarters last year made up just one-third of its full-year sales. By contrast, the fourth quarter alone was responsible for a full third of the company's total revenue, and that's where Mattel's problems truly began.

Mattel's fourth-quarter 2013 worldwide net sales fell 6%. The reason Mattel's 2013 fourth quarter is spilling over into the current year is that it's stuck with a major inventory overhang, which it presumably built up anticipating strong demand. That didn't happen, and it's still paying the price for that mistake.

However, Mattel is working through inventory. Mattel-owned inventory fell by $100 million in the first half of this year relative to year-end. Its U.S. inventory fell by the mid-single digits with only "pockets" of high inventory remaining in a few international markets.

In addition, Mattel is building on some exciting new opportunities that will allow it to branch out into new categories.

Growth strategy intact
Another reason to be bullish on Mattel's future is that it has a budding partnership with the largest online retailer in the world, which will both open a new retail channel and enhance Mattel's mobile presence.

According to The New York Times, the two companies are preparing the launch of children's cartoon Fireman Sam, which is a hit internationally but has yet to be brought to the United States.

About 75 episodes of the cartoon will be available this year. Of course, merchandise will be soon to follow. Episodes and themed products will be sold exclusively on Amazon. In a way, this partnership will simultaneously create and fulfill consumer demand.

Partnering with Amazon will provide Mattel two major opportunities at the entertainment and retail levels. Amazon's status as the largest online retailer will allow consumers to instantly purchase Fireman Sam products on their mobile devices after watching the show. This comes at just the right time for Mattel since children are increasingly consuming entertainment on devices.

Separately, Mattel acquired Mega Brands earlier this year, which provides instant access into a major new product category. Mega Brands is the No. 2 player in construction toys and is the biggest competitor to Lego's empire. This gives Mattel a strong position in a $4 billion industry worldwide.

This toy story has a happy ending
On its earnings conference call, Mattel management referred to the first half of the calendar year as the preseason, which is when it lays the groundwork for the all-important second half. Mattel's first half of 2014 looks bad based on the hangover from last year's poor fourth quarter. In addition, Mattel is suffering with bloated inventory that's making the company look like a lumbering giant.

But there's still reason to be optimistic. Mattel has almost worked through its inventory challenges. Mattel is also building a partnership with Amazon that should boost its mobile presence, and it acquired Mega Brands, giving it entry into a new product category.

For value investors, Mattel looks ripe for the picking. The stock trades for just 13 times forward earnings and offers a 4.2% dividend yield. If it can keep working through its inventory buildup and its strategic initiatives gain traction, this could be a great entry point.

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