Mattel (NASDAQ:MAT) stock tumbled 5% on the day it released earnings.
Over the past year, Mattel has been besieged by falling sales for its flagship Barbie and Fisher-Price brands. Investors have lost patience with the company's painful decline, which led to the resignation this week of Chief Executive Officer Bryan Stockton.
Investors also have apparently lost faith in management's ability to turn Mattel around. It's difficult to say anything positive about the toy maker now. Sales declined last year, and earnings fell significantly because of higher expenses. Mattel spent a lot of money last year on a large acquisition and increased advertising, but these measures failed to engineer a turnaround. For these reasons, Mattel is shrouded in uncertainty.
Assessing Mattel's risks
Mattel announced that fourth-quarter revenue fell by 5%. Earnings collapsed by 58% to $0.44 per share, the company estimated, badly missing analysts' consensus estimate of $0.92 per share. Mattel's profits were hurt by significant costs associated with its acquisition of MEGA Brands. This caused SG&A expenses to increase by 390 basis points. Unfavorable currency fluctuations shaved another 3 percentage points off total revenue.
Not surprisingly, Mattel's deteriorating fundamentals have caused the stock to collapse by 37% over the past year. Most concerning is Mattel's inability to stem the slide in toy sales. This presents a dire outlook in an age in which more children are adopting digital games on their tablets and other mobile devices.
Management hoped the $460 million acquisition of MEGA Brands would help in this regard. In early 2014, Mattel acquired the Canadian company to capture a leadership position in the construction-play market, which is still growing. In fact, Lego passed Mattel to become the world's largest toy maker last year. Unfortunately, the acquisition did little to spur a turnaround.
Mattel's construction toy segment produced $315 million in sales, or about 5% of Mattel's total revenue, but absorbing MEGA Brands was a costly acquisition that resulted in significantly higher marketing spending. Gross margin as a percentage of net sales declined by 380 basis points last year, which management attributed to the acquisition. Furthermore, integration costs associated with the takeover shaved another $0.16 per share, or about $54 million, off Mattel's full-year earnings.
Overall, sales fell across Mattel's product categories last year. Girls and boys brands posted a 10% sales decline last year, led by a 16% drop in Barbie sales. Fisher-Price sales fell 13%, and even American Girl, which had been Mattel's only successful brand throughout most of the year, saw sales decline by 2% in 2014. Clearly, this is a broad-based deterioration.
Mattel's turnaround prospects in 2015 are questionable. Analysts expect earnings to remain flat. Another key headwind is the looming disappearance of a prized growth asset. In September, Disney announced that licenses for toys based on the hit movie Frozen will go to Mattel archrival Hasbro starting next year. This will only add further pressure to Mattel's bottom line. Mattel does not break out sales of the Frozen line specifically, although analysts cited by Fortune Magazine recently pegged the annual figure at $500 million. Losing this revenue would cause Mattel's annual sales to decline by another 8%.
Income investors, tread carefully
Perhaps the only positive thing one can say about Mattel stock is it offers a very high dividend yield, which stands at 5.7% (a three-year high) and probably looks attractive for income investors.
But investors need to be cautious about reaching for yield, when the company itself is in trouble. Mattel's high dividend yield is the result of its collapsing share price, not because of dividend growth. Typically, Mattel increases its dividend after announcing fourth-quarter earnings. This time around, Mattel froze the dividend. This is understandable given the company's deteriorating fundamentals, but is a bad sign nonetheless.
With the sudden departure of its Chief Executive Officer after a terrible year for the company, Mattel is shrouded in uncertainty. The company is bleeding cash, due to declining revenue and profits, as well as an expensive acquisition last year and higher expenses associated with the takeover. For these reasons, take a pass on Mattel and its tantalizing dividend.