Hasbro (HAS 10.82%), one of the world's largest toy and game manufacturers, has a long history of returning excess cash to shareholders. Although share repurchases were suspended in the first quarter of 2020 due to the company's $3.8 billion acquisition of Entertainment One (eOne), it remains committed to paying a healthy dividend.
Dividend stocks attract investors who demand a consistent, predictable income stream from their portfolios. While Hasbro has seen its stock fall 33% so far this year compared to the S&P 500's 5% decline, the limitless number of income-focused funds and investors in the market provides a certain level of support for the share price.
Since 2010, Hasbro's annual dividend payments have grown at a compound annual growth rate (CAGR) of almost 12% to reach $337 million in fiscal 2019. The company's net income, on the other hand, has risen just 3% per year over that same time period. This has resulted in a doubling of the dividend payout ratio from 30% in 2010 to 65% in 2019. How should long-term investors interpret this trend?
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Dividend pros and cons
Proponents of corporate dividend policies like that they signal a company's financial well-being. If Hasbro is able to pay steady dividends over long stretches of time, then it must be a stable business with solid future prospects. Because shareholders expect dividends quarter after quarter, management is forced to stay disciplined -- any decrease or elimination of distributions will probably hurt the stock price. Furthermore, the payout attracts a steadier shareholder base that cares less about near-term price movements and more about holding a reliable, income-generating asset.
On the flip side, a rising dividend payout ratio is also an indication that reinvestment opportunities to increase the intrinsic value of the business are limited. If Hasbro did have a long growth runway ahead, then it should be plowing most of its earnings and free cash flow into taking market share, expanding into new products and services, and improving its competitive position. Consequently, management might get so focused on paying a dividend to keep shareholders happy that it neglects investing in the business to better position it for the future.
Investing in growth
Hasbro has experienced anemic growth over the past decade. Sales were only 18% higher in fiscal 2019 than they were in fiscal 2010. The company's target demographic -- children -- is gravitating toward digital entertainment. While Hasbro was growing its dividend, companies like Activision, Take-Two Interactive, and Electronic Arts dominated the video game space and saw their stock prices soar. Hasbro management forecasted reduced capital expenditures on digital gaming development in 2020. Though the company does focus on a younger audience, the world is going digital, and Hasbro should be much more focused on this space.
The purchase of eOne provides some hope for investors going forward. With the acquisition, Hasbro now owns significant media assets, particularly in TV and film. This gives the company huge reinvestment opportunities. After spending a total of $34 million on program production in 2019, Hasbro management estimates that figure to be in the range of $500 million to $600 million this year. However, eOne was acquired to achieve sustainable, profitable growth, and the goal of the combined entity is to deliver only mid-single-digit revenue gains in the medium term. This is not impressive at all.
The future of Hasbro
I'd much prefer a company that invests in new avenues for growth projects or acquire complementary businesses if the prospects for boosting free cash flow are meaningful. In Hasbro's case, it chose to continue increasing its dividend and flaunting it as a source of corporate pride, instead of focusing intensely on the growing market for digital entertainment. Additionally, Hasbro borrowed $2.4 billion of unsecured debt to buy out a company that requires substantial additional investments to produce content but won't provide much to enhance the bottom line.
On the fiscal first quarter earnings call, CFO Deborah Thomas said that "the board remains committed to our dividend." For Hasbro, it seems the only way to attract investors is to push the dividend aggressively. Although the company is a perennial low-growth name, the stock is still trading considerably off all-time highs and carries a price-to-earnings (P/E) ratio of 19.2 as of this writing. Are you going to roll the dice?
