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A Look at Mattel’s Profitability
Posted by: Damian Illia (IP Logged)
Date: February 24, 2014 03:42PM

Children’s play patterns have been shifting towards digital products, and away from the traditional toy segment, over the past few years. However, toy manufacturer Mattel Inc. (MAT) is taking measures to develop its products, as well as augment its marketing plans and consumer engagement tactics, in order to counterbalance this trend. Furthermore, as the largest company in the toy industry, it enjoys supreme brand strength via the Barbie, Hot Wheels, Fisher-Price, and American Girl products, which continue to drive growth. While the company still faces industry competition from Hasbro Inc. (HAS), apart from the aforementioned headwinds, its increasing dividend yield of 4.10% and frequent share buybacks should be tempting for investors.

Profitability is one of the main factors one must look at when analyzing a company. It is not only the reason behind a company’s existence, but also a key element when determining whether to invest in a company or not. Thus, in this article I will look into Mattel’s earnings growth, profit margins, profitability ratios and cash flow. Additionally, I will evaluate which institutional investors bought the stock in the recent quarters (institutional backup can tell a lot about a stock).

Earnings Growth

First, I would like to take a look at Mattel’s earnings growth. For many stock investors, the most important thing is growth and, specifically, growth in earnings, as this is what fuels aggressive growth stocks. Therefore, it is of utmost importance that investors have an idea of how long a company can sustain a certain level of earnings expansion. The company's valuation, and thus the stock price, is almost completely dependent on this fact.

The first step is analyzing the firm’s latest EPS growth rates. The company generated -4% quarterly EPS growth in 2013 when compared to the same quarter last year. FrankIy, the fact that Mattel generated less than 15% quarterly EPS growth is somewhat disconcerting, but it’s key to highlight that analysts just upgraded their estimates for the current year, increasing projected quarterly EPS to 2.64%.

EPS Growth vs. Revenue

It’s important to point out that both EPS and sales growth should occur at similar levels, if the company is profitable. Mattel reported a 15.26% quarterly sales growth year over year. Considering my minimum revenue growth rate requirement of 15% for these kind of companies, I am encouraged by this firm’s growth levels. The fact that revenues grew more than earnings per share is also very encouraging.

If a company generates strong EPS growth levels and even stronger revenue growth levels, I tend to feel very bullish about it. Mattel generated quarterly EPS growth of -4%, while sales grew by 15.26%. Furthermore, the company showed a three-year annual sales growth rate of 5.74%.

Gross Profit Margin

The gross profit margin measures a company's manufacturing and distribution efficiency during the production process. It also tells an investor the percentage of revenue/sales left after subtracting the cost of the goods/services sold. Investors tend to pay more for businesses that have higher efficiency ratings, as these should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

In the case of Mattel, its gross margins have increased over the past years. The five-year low for the gross margin was reported at 45.4%, while the current margin of 53.1% is the five-year high point. Moreover, the TTM gross profit margin of 53.6% is above the five-year average of 49.84%, implying that management has been successful in making manufacturing and distribution more efficient over the past five years.

Operating Margin = Operating Income / Total Sales

This metric establishes what proportion of a company's revenue is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. Needless to say: the higher the margin, the better.

Over the past five years, the toy manufacturer’s operating margin has been increasing. In 2009, the company reported an operating margin of 9.2%, while this figure reached 16.0% over the past 12 months. This TTM operating margin is higher than the five-year average of 14.12%, implying that the total sales left over after paying for variable costs of production have increased, compared to the five-year average.

Net Profit Margin = Net Income / Total Sales

This ratio measures how much out of every dollar of sales a company actually keeps in earnings, being very useful when comparing companies in the same — or similar — industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. A 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

Over the past five years, Mattel’s net profit margin has been increasing. The TTM net profit margin of 12.69% is above the five-year average of 10.44%, implying that there has been an increase in the percentage of earnings that the company is able to keep compared to the company's five-year average. This also shows that the company is gaining strength.

ROA - Return on Assets = Net Income / Total Assets

The ROA metric gives us an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

The 2012 ROA of 12.93% is slightly above the five-year average of 11.83%. This implies that management has ameliorated its ability to use the company's assets to generate earnings over the past five years.

Free Cash Flow = Operating Cash Flow - Capital Expenditure

Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base and is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

Mattel generated a ratio of cash flow from operations/total sales of 91.92. If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even though the company can generate revenue, it is losing money.

Institutional Investors

It is important to check which hedge funds bought the stock in the last quarter and at what price they did so. In the recent quarter, for example, both Joel Greenblatt (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) — among other prominent investors — bought the company’s stock at an average price of $43.73.

Analyst Outlook

Currently, many analysts have a good outlook for Mattel. Analysts at MSN money are predicting that the firm will retrieve an EPS of $2.90 for fiscal year 2014, while analysts at Bloomberg estimate revenue to grow at a 7.3% rate and close at $6.77 billion for fiscal year 2014.

Is the Future Bright?

Despite some complications considering children’s shifting interest toward digital products, I remain bullish about Mattel’s ability to counteract with technological innovations. I’m basing my judgement mainly on the company’s solid balance sheet, although I advise investors to consider a medium-term investment at the most. This is due mainly to skepticism regarding the 40% sales retrieved from the firm’s three biggest outlets — Toys ‘R’ Us, Wal-Mart Stores Inc. (WMT), and Target Corporation (TGT) — which could decline as consumers shift towards online purchases. However, the stock's 35% price discount relative to the industry average of 22.90x, could make this a good time for investors looking to buy shares at a low price.

Disclosure: Damian Illia holds no position in any stocks mentioned.




Guru Discussed: Jeremy Grantham: Current Portfolio, Stock Picks
Stocks Discussed: MAT, HAS,
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