Is It Finally Time to Buy Mattel?

Mattel's (MAT -0.66%) stock recently popped after the toy maker posted strong third-quarter numbers that topped Wall Street's expectations. Its revenue rose 3% annually (4% in constant currency terms) to $1.48 billion, clearing estimates by $40 million and marking its second straight quarter of growth on a reported basis.

Mattel's non-GAAP earnings rose 44% to $0.26 per share, beating estimates by $0.07 and marking its first adjusted profit in three quarters. On a GAAP basis, its earnings rose tenfold to $0.20 per share.

Image source: Getty Images.

Those strong numbers indicate that Mattel could finally be turning a corner after disappointing investors in February with a forecast for flat sales growth and soft earnings growth for the full year. But do those numbers mean that the stock will finally rebound after dropping nearly 20% over the past three months?

The key numbers

Mattel generates its revenue from four core businesses. Here's how they fared during the third quarter.

Source: Mattel Q3 report.

The dolls unit was lifted by a 12% increase in Barbie sales, which marked the iconic brand's eighth straight quarter of growth. That growth engine, along with the strength of its new Polly Pocket dolls, offset a 14% drop in American Girl sales.

Its infant, toddler, and preschool unit remained a sore spot due to soft demand for its Fisher-Price and Thomas and Friends products. However, Mattel notes that sales of its core Fisher-Price toys are improving overseas, and that it's streamlining its Thomas and Friends lineup ahead of an aggressive turnaround effort in 2020.

The vehicles unit was supported by a 27% jump in Hot Wheels sales, which offset weaker sales of older vehicles for Walt Disney's (DIS 0.16%) Cars and Universal's Jurassic World.

Lastly, Mattel's action figures, building sets, and games division benefited from the launch of Disney's Toy Story 4 action figures, which coincided with the movie's release in June. The unit's other growth engines included its MEGA building sets and card games like UNO and Face 10.

Image source: Getty Images.

Improving margins and stable debt

Mattel isn't sacrificing its margins to boost its sales. Its adjusted gross margin expanded 390 basis points annually to 46.9%, as its adjusted operating margin rose 110 basis points to 11.7%.

Mattel attributed its margin expansion to "structural simplification savings," which eliminated redundancies, scaled back weaker product lines, tightened up its advertising budget, and expanded its brands through digital platforms and other content.

Mattel's long-term debt remained nearly unchanged year over year at $2.86 billion. It stated that it would refinance $250 million in senior notes, which mature in October 2020, but CFO Joe Euteneuer noted during the conference call that Mattel had "sufficient liquidity to both run the business efficiently and to make strategic investments to grow."

Mattel also noted that it resolved the accounting issues initially exposed in a whistleblower letter in August, which had caused the company to terminate a sale of senior notes due in 2027.

During the call, CEO Ynon Kreiz stated that PwC auditors determined that the company's income tax expense had been understated by $109 million in the third quarter of 2017, then overstated by $109 million in the fourth quarter of 2017 -- but had no impact on its full-year results. Kreiz also announced that Euteneuer will step down as CFO and that Mattel was conducting a search for his successor.

The road ahead

Mattel expects its full-year sales to be "up slightly" in constant currency terms. On a reported basis, it expects its sales to be roughly flat. That growth looks soft, but it finally breaks Mattel's five-year streak of revenue declines.

The company didn't provide an exact earnings estimate, but it expects its gross margin to expand and for its adjusted EBITDA to more than double to $400 million to $425 million. It also expects to generate a full-year positive operating cash flow for the first time in three years. Those improvements might lead Mattel to eventually reinstate its dividend, which it suspended two years ago.

Wall Street expects Mattel's revenue to dip 1% this year and for its adjusted earnings to rise 65%, and for that recovery to continue with 2% revenue growth and 138% earnings growth next year. Hasbro (HAS 0.60%), by comparison, is expected to generate 9% sales growth and 24% earnings growth next year.

Mattel trades at nearly 80 times next year's earnings, which looks pricey relative compared to Hasbro's forward P/E of 20, but that multiple is inflated by its previous losses. In terms of revenue, Mattel still looks cheap at less than 1 times next year's sales.

Should you buy Mattel?

Mattel's business is stabilizing, its margins are improving, it's containing its debt, and it's addressed the accounting issues that torpedoed the stock in August. Therefore, I think value-seeking investors should consider accumulating some shares of this battered toy maker.