Five years ago, my wife and I bought our son a Playmobil pirate ship for Christmas. Sure, it was a bit pricey, but the ship remains in good condition and will be ready to set sail again for my baby daughter in a year or two. Last year, we spent somewhat less for a Hot Wheels set from Mattel (NYSE:MAT). It was broken and abandoned before we even sat down to Christmas dinner. With toys I guess, you get what you pay for.
The same can be said of stocks. There are some observers, like my good friend Rich Smith, who think that Mattel is undervalued and therefore a good stock idea. It is, after all, a well-known brand that delivers a 3% dividend yield. Unfortunately, the future is bleak for this toy maker, and its shares look a lot better under the tree with a shiny bow attached than they would if they were actually in your portfolio.
Coal in your stocking
Recent history has been dire for investors in Mattel. Over the last year, the company has delivered a dividend-adjusted return of negative 10.58%. If you had purchased the stock two years ago, you would have earned an annualized, dividend-adjusted return of negative 5.44%. Things are somewhat better over the last five years, as the stock has delivered an annualized adjusted return of 7.16%. On the whole, a pretty unimpressive performance, even when considering the healthy dividend that everyone is always crowing about. So if there is a case to be made for Mattel, it must depend on the company turning things around. Is this company on the verge of improving its operating performance?
Not if you look at its profit margins. The following table illustrates some worrying trends:
| 2003 | 2004 | LTM Sept. 30, 2005 | |
|---|---|---|---|
| Gross margins | 49.1% | 47.2% | 45.8% |
| Operating margins | 16.2% | 14.8% | 13% |
| Net margins | 10.8% | 11.2% | 8% |
This table tells a sad story of declining profitability. And you don't need an MBA from the Wharton school to know that this is not good. A look at the last couple of income statements reveals that the company's costs are rising faster than its revenues. As Nathan Parmelee pointed out recently, the company plans to negotiate price increases from the likes of Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) to bolster its declining margins. Let's consider this for a moment: Mattel's strategy consists of asking the low-price mega-retailers to allow it to charge higher prices? Good luck with that.
I should point out that there is an additional arrow in Mattel's quiver. The company is aiming to boost Barbie sales, which were down 18% worldwide and 30% in the U.S. in the most recent quarter. In the most recent conference call, management blamed Barbie's troubles on distribution shortcomings. In other words, there's nothing wrong with Barbie that more shelf space and greater awareness can't solve. Maybe. Looking at that 30% decline in the U.S., though, one can't help but wonder if there is a larger trend at work here. Is Barbie part of another age of drive-in burger joints and moms who look like June Cleaver? One thing seems clear: I wouldn't bet the farm on Barbie being the most popular gal at the sock hop in 2006.
Babes in Toyland
Mattel's declining margins and unimpressive turnaround strategy is enough for me to steer clear of this stock. In fact, I sold my only shares of this company that I held on behalf of my son after our poor experience with Hot Wheels last Christmas.
For those investors who are inexplicably still interested in this company, it might be helpful to compare the stock with a few of its competitors. I have chosen to compare it with two toy makers and one other company in the leisure industry.
| P/E* | Growth rate** | Operating margin* | Return on equity* | |
|---|---|---|---|---|
| Hasbro (NYSE:HAS) | 19.6 | 10.6% | 9.4% | 12.6% |
| JAKKS Pacific (NASDAQ:JAKK) | 10 | 14.3% | 13.9% | 13.6% |
| Marvel (NYSE:MVL) | 16.5 | 12.8% | 45.6% | 22% |
| Mattel | 16 | 9.4% | 12.9% | 18.6% |
*LTM Sept. 30, 2005
**Estimated five-year annualized growth rate
Information provided by Capital IQ
As we can see, Mattel's five-year annualized earnings-per-share growth rate is the lowest of the group. Its operating margin trails JAKKS and Marvel, but is stronger than Hasbro, while its return on equity figure is respectable. Overall, Mattel clearly isn't the best of this lot, but it probably isn't the worst either.
With all the great stock ideas out there, I'm not sure why anyone would be considering Mattel. Maybe Barbie can make a comeback and the company can reverse the downward trend in margins. And maybe there's an overweight Nordic bloke who rides around the world in one night in a reindeer-driven sleigh. Maybe.
Our value-hunting newsletter,Motley Fool Inside Value, recommended Mattel as one of its two inaugural picks. It hasn't paid off for us yet, but the rest of our portfolio is up better than 10% to the S&P's 7%. You can see all of our other recommendations any time you like, but you'll need to take afree 30-day trialto do it.
Hasbro and Marvel areMotley Fool Stock Advisor selections.
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John Reeves does not own shares in any of the companies mentioned in this article. The Motley Fool is investors writing for investors.
