Mattel (NASDAQ:MAT) held its annual Toy Fair analyst day on Feb. 15, and investors clearly weren't impressed. The toy company's stock, which rallied after its fourth-quarter earnings a week earlier, gave up a large portion of its post-earnings gains. Let's examine the four key issues that spooked the bulls and attracted the bears.
1. Flat sales growth
Mattel's sales fell 8% (7% on a constant currency basis) in fiscal 2018, due to the liquidation of Toys R Us, sluggish sales in China, and weak demand for Fisher-Price, Thomas & Friends, and American Girl products.
Analysts previously forecast Mattel's revenue to rise about 2% this year. But during the Toy Fair presentation, CFO Joe Euteneuer announced that Mattel would post flat constant currency sales growth in 2019 instead. He also noted that currency headwinds would have a "low single-digit negative impact" on Mattel's gross sales -- so its reported growth will be negative.
Euteneuer also noted that Barbie and Hot Wheels, its two core growth engines last quarter, would post continued growth but not to the extent of the gains in 2018. The outlook for Barbie was particularly disappointing, since the bulls expected the brand's sales to accelerate with the launch of new 60th anniversary products this year.
Mattel expects Fisher-Price sales to stabilize by the end of the year, but Thomas & Friends and American Girl are both expected to continue their declines.
2. Historically weak margins
The bulls cheered last quarter when Mattel's gross margin expanded 540 basis points annually to 46.6% last quarter, marking its first fourth-quarter gross margin expansion since 2013. That expansion boosted Mattel's full-year gross margin to 39.8% -- marking a 250 basis point improvement from 2017.
Euteneuer anticipates Mattel's gross margin to expand again to the low 40s in 2019. That forecast wasn't bad, but it would still remain well below its historical gross margins:
Investors were probably expecting a more meaningful margin expansion, since rival Hasbro's (NASDAQ:HAS) average gross margin remained in the low 50s over the past 12 months.
3. Lower-than-expected adjusted EBITDA
Mattel expects its sluggish sales growth and slow gross margin expansion to throttle its adjusted EBITDA growth. Analysts originally predicted Mattel's adjusted EBITDA to surge 179% this year, but its new forecast calls for just 77%-102% growth.
For the year, Mattel sees its adjusted operating income to be "slightly positive," compared to operating losses of $207 million and $115 million in 2018, respectively.
That outlook seems solid, but it indicates that Mattel's return to profitability following two full-year losses could come in weaker than expected. This means that Mattel's forward P/E of 31 -- which is based on earlier analyst forecasts -- will rise significantly after analysts update their estimates. Hasbro, by comparison, trades at just 17 times forward earnings.
4. Questionable media ambitions
Mattel highlighted four films during its presentation: Hot Wheels and Barbie movies from AT&T's Warner Bros., a Masters of the Universe movie from Sony, and an American Girl film from MGM. It also unveiled a slate of 22 new licensed TV shows.
These films and TV shows don't pose major financial risks to Mattel, since it's merely licensing out its brands and offering creative input to studios. However, Mattel is throttling its SG&A spending as it expands those media efforts, which indicates that it wants to supplant traditional ads with TV shows and movies. This strategy mirrors Hasbro's approach with Transformers and G.I. Joe.
That effort might pay off for certain brands, like Barbie or Hot Wheels, but it might not revive interest in weaker brands like American Girl. This strategy, which only kicked into high gear last fall with the launch of the new Mattel Films division, could quickly collapse if its films bomb or its TV shows fail to reach enough viewers.
The bottom line
I recently predicted that Mattel would rally higher this year, based on the strength of its core brands, its expanding margins, rising earnings, and valuation. Its Toy Fair presentation threw some cold water on my thesis, but I think Mattel's overall fundamentals are still improving. I think investors should watch the stock for a few more quarters before making a long-term call.