Mattel (MAT -0.03%) is in transition, recovering from several internal problems like the protracted decline of its Fisher-Price and American Girl brands, along with external issues, such as the bankruptcy of Toys R Us. Those concerns led to heavy speculation it would be bought out, and rival MGA Entertainment even made a half-hearted attempt.
Yet when the toymaker reports its second quarter earnings on Thursday, July 25, investors might be surprised to see how far along it has progressed. Although factors like an expensive recall of its Fisher-Price Rock 'N Play Sleeper could weigh on results, the overall direction Mattel is headed is the right one and there is good reason to expect it will recover faster than many expect.
Reinventing the Barbie doll has created a source of sales strength for Mattel. Image source: Mattel.
Surmounting a weak market
The toy maker isn't providing quarterly earnings guidance during the turnaround effort, preferring to give just an annual outlook. That outlook deflated investor expectations last time, because Mattel had posted strong first-quarter results, with sales up 1% on a currency-adjusted basis. As a result, it was disappointing when management said it was looking for sales to be flat in 2019.
However, analysts are looking for Mattel to post revenues of $820.6 million in the second quarter, down just 2% from last year. Although they also forecast a loss of $0.35 per share for the period, that's a significant improvement over the $0.56 per-share loss it notched in the year-ago quarter.
Mattel's main priority is to return to profitability, and the year was off to a strong start as gross margins, operating income, EBITDA, and per-share earnings moved meaningfully in the right direction, with working capital and operating cash flow also greatly improving. The toy maker expects adjusted EBITDA to finish the year well in the black, in a range of $350 million to $400 million, though most of the gains will occur in the back half of the year.
Momentum turning its way
Despite the Toys R Us bankruptcy and liquidation casting a long shadow on the industry, Mattel was able to make up a lot of lost ground as other retailers stepped forward to expand their shelf space for toys. After four straight years of toy sales growth, NPD Group says these sales fell only 2% in 2018, and were higher than they had been two years prior.
That bodes well for Mattel this quarter, as the bar it has to get over has been set quite low. Last year's sales of $840.7 million were down 14% from the prior period, so analysts may be underselling the potential recovery too much. The Toys R Us hole isn't quite so deep, and Easter was moved into the quarter, unlike last year when it was in the first quarter. That should give the toy maker a little boost, as Mattel said the holiday shift was a low-single-digit hit to sales.
It should receive another bump from the release of Pixar's Toy Story 4. Although the movie opened in late June, merchandise supporting the film shipped earlier, and box office results indicate the franchise still has significant staying power. The movie was critically praised and earned a 98% Rotten Tomatoes score.
Toy Story 4 enjoyed a bigger opening weekend than any of the other movies in the franchise; although it also had a wider release than the others, it has already earned almost $860 million in worldwide receipts since its June 21 release, which is close to the $1 billion Toy Story 3 amassed.
Mattel has also expanded its global licensing agreement with Disney (DIS -0.11%), giving it access to old and new Pixar franchises, including Finding Nemo, Monsters, and the upcoming Onward. The agreement won't take effect until next May, so it won't have an impact on this quarter's results (or this year's), but it has the potential to be a big sales driver for the toy maker.
A surprise in the making
Mattel still has a lot of wrinkles to iron out. American Girl is a mess, Thomas & Friends is hurting, and the Fisher-Price brand is sluggish. Yet demand for Barbie and Hot Wheels is still huge, and there are movies for the brands in the works, so even if it hits a few rough patches, there is a new, more solid foundation underneath.
Investors should get a view of how that's working out this week, and the market may be surprised it is coming along better than expected.
