3 Reasons to Believe in Mattel’s Turnaround

Mattel (MAT 0.19%) is the maker of top names in toys, including Barbie, Hot Wheels, Fisher-Price, and Thomas & Friends. Prior to 2015, Mattel was one of the best-performing toymakers, with sales steadily growing from $5.4 billion in 2009 to $6.5 billion in 2013. At the same time, net profit margin expanded from mid-single digits to nearly 14%. Its stock was not only outperforming the broad market but also its main rival Hasbro (HAS -1.46%).

Data by YCharts.

But starting in 2014, things went downhill in a hurry. Costs got out of control just as a soft retail market caused lower demand for some of Mattel's toy brands. The company went from generating $1.1 billion in pre-tax profit in 2013 to losing over $1 billion in 2017.

There's no reason why Mattel shouldn't be able to perform like Hasbro, which generates about the same level of revenue but more consistent profits every year. 

There were clearly mistakes made by Mattel's previous management team, but new leadership is implementing a plan that if successful, can make Mattel stock a steal at current prices. 

Barbie sales were up 18% in the first quarter of 2018. Image source: Mattel.

1. Core brands are growing

The company has changed leadership several times in the last few years, with CEO Ynon Kreiz recently taking over. He is overseeing a complete overhaul of the company's cost structure to focus on areas that have served competitor Hasbro well in recent years, such as digital entertainment experiences based on core toy brands.

Excluding sales to now-defunct Toys R Us (which made up around 10% of Mattel's annual revenue), sales grew 2% year over year in the first quarter, which is encouraging.

Management reported that the Barbie brand is "hot" as worldwide gross sales increased 18% in the first quarter (excluding currency charges). Hot Wheels were similarly strong with currency-neutral sales growth of 11% over the year-ago quarter. Those two brands made up 37% of Mattel's total gross sales in the quarter and will be heavily relied upon to pull Mattel out of its rut.

There is clearly solid momentum right now for Mattel's top toys, and it shows why cutting out unnecessary investments in other areas should help bring Mattel back to profitability.

2. Cutting costs

Mattel is currently on pace to cut $650 million in costs through 2019, with 40% of those cuts to be realized in 2018. Management doesn't provide guidance for earnings, but it expects gross margin to improve from 37.3% in 2017 to the low 40s by the end of 2018, as cost savings begin to kick in.

The consensus analyst estimate calls for Mattel to report a loss of $0.48 per share in 2018, which would be a significant improvement over the $1.08 loss in 2017 on a non-GAAP basis. As the remaining cost savings are realized next year, analysts expect the company to report a profit of $0.40 per share in 2019, and earnings should grow from there.

3. Investing in mobile games

Mattel made a great move earlier this year in partnering with Chinese internet technology company NetEase, which makes some of the most popular games in the largest mobile-gaming market in the world.

Mobile gaming is expected to top $70 billion this year, up 25% over 2017, according to Newzoo. NetEase and Mattel are forming a game development studio called Mattel163, which will focus on making mobile games based on Mattel's classic toy brands.

Mattel stock is in the bargain bin

The key to a successful turnaround is getting costs under control and investing in the right areas, which Mattel is clearly doing as shown with the NetEase partnership.

With management trimming the fat and prioritizing its investments, it's within Mattel's ability to return to at least a 10% profit margin, which it generated prior to 2015. 

Data source: Mattel. Amounts in million except per share data. *TTM = trailing 12 months through Q1 2018.  

Current trading levels present an attractive opportunity for investors if you believe in Kreiz and his team's ability to rework this nearly 75 year-old toy business and bring it closer in line with rival Hasbro.