Mattel (NASDAQ:MAT) is one of the top toy brands in the world, known for classic icons like Barbie and Hot Wheels. But its share price has fallen 67% over the last five years. Weak demand and bloated costs have weighed on the company's performance, but a new CEO took over in 2018 and has had success in stabilizing sales growth while stripping out unnecessary costs to improve profitability. 

Before the COVID-19 crisis, the company's top brands were seeing improving sales trends. In 2019, Mattel managed to increase its market share during the fourth quarter, remaining the No. 1 global toy company, according to NPD Group. 

Mattel faces a rough road ahead in 2020, but there are three reasons why Mattel should emerge from this crisis stronger and remain a compelling turnaround play.

Two young boys playing with a Hot Wheels racing track.

Image source: Mattel.

1. The turnaround strategy has shown promise

As expected, there was nothing to like in Mattel's first-quarter earnings report. With retail doors closed, Mattel's sales dropped 14% year over year, and the second quarter will be worse. The important thing is that management is continuing to strip out costs to improve gross profit margin. 

The recent quarter overshadows the positive trends Mattel was experiencing going into the economic shut down. Last year, net sales increased 1% on a constant-currency basis, driven by a 9% increase in sales of Barbie and a 14% increase in Hot Wheels. The 1% increase in sales doesn't sound like much, but it's a world of difference compared to the erosion on the top line before CEO Ynon Kreiz took over in April 2018.

What's more, the company stripped out $875 million in costs, which allowed Mattel to report an operating profit of $39.2 million last year -- its first profitable year since 2016. The trend certainly points to better days ahead.

Management expects to cut additional costs in 2020 to bring the cumulative savings since the beginning of the cost-cutting program to more than $1 billion by the end of the year. Most importantly, most of Mattel's sales are supported by a variable cost structure, which means that management can adjust inventory and advertising expenditures to match the lower demand, helping to minimize losses from lower sales due to the COVID-19 outbreak. 

2. Enough liquidity to get through the near-term turmoil

While Mattel held $3 billion of total debt and only $499 million of cash at the end of March, only $150 million of the debt is due in the short term. Management refinanced its debt last year, so there are no maturities until March 2023. All told, Mattel won't face a credit crunch.

3. Management sees a recovery on the horizon

The first quarter wasn't all bad news. Management reported that it saw demand for games as parents bought toys to keep their children entertained. During the conference call on May 6, management reported that online point-of-sale in the U.S. was up 90% quarter to date. However, the online sales growth hasn't been enough to offset lower sales at stores in the dolls and infant/toddler preschool categories, which make up nearly 60% of Mattel's annual sales. 

Moreover, Mattel's manufacturing supply chain has been disrupted, but management expects to be able to meet demand in the second half, which is Mattel's peak season for production. During the recent conference call, CEO Ynon Kreiz said, "Our supply chain organization has largely restored global manufacturing and distribution capacity, and we believe that operations are on the right path to meet our production needs for the second half of the year leading up to and including the holiday season." 

Kreiz added that with approximately 65% to 70% of Mattel's sales usually generated in the second half of the year, "there is time to regain sales momentum." He pointed to the company's internal research where parents have communicated to Mattel that the current situation won't impact their spending for the holidays later this year. 

While the toy industry is not immune to the impact of a recession, Kreiz believes that parents will continue to prioritize spending on toys, which supports his belief that the toy industry will perform relatively well against other consumer-discretionary industries. 

A promising turnaround story

The second quarter will be worse than the first, as planned product releases around the Olympics and the launch of Minions: The Rise of Gru from Universal Studios have been delayed, with those events being pushed back until 2021. But there is plenty of bad news already reflected in the stock's valuation. The shares currently trade at the lowest price-to-sales ratio since the Great Recession in 2008. 

MAT PS Ratio Chart

MAT PS Ratio data by YCharts

As management continues to trim costs, Mattel should see its profitability rebound on the other side of this downturn. Longer term, Mattel is taking a page out of Hasbro's playbook to expand its sales beyond toys to licensed TV series on Netflix (e.g., Masters of the Universe: Revelation) and to the silver screen, where projects are under way in partnership with top Hollywood studios for movie adaptations of Barbie and Hot Wheels, among others. 

All in all, if Mattel continues to make progress in its turnaround efforts, this value stock could be rewarding. From the depths of the market crash in Dec. 2008, Mattel saw its share price soar 197% over the following five years. That's not a guarantee that history will repeat itself, but there is potential for a rebound in the stock price coming out of this recession.

Mattel has valuable toy brands, and current management is clearly making progress to improve profitability and position top franchises for long-term growth across different entertainment channels. All said, the stock offers plenty of upside from these lows, as management implements cost-saving measures and consumer spending begins to recover as the year progresses.