Should you follow Carl Icahn into Mattel?
I wrote an article about Mattel back in January. The presentation is sketchy – I wrote it in outline form – but it’s got all the numbers you need to value the stock.
I’m sticking with the basic point I made in January. Mattel is a great business. It might be a good stock. But it is not a great stock. A company with Mattel’s “earning power” should trade for about $25 a share. And that’s where Mattel is trading right now.
Mattel’s Vital Signs
1. Z-Score: 7.00
2. F-Score: 6
3. FCF Margin: 10.25%
4. Return on Capital: 23.28%
5. FCF Margin Variation: 0.45
6. Return on Capital Variation: 0.24
7. Price/10-Year Real FCF: 16.18
8. EV/10-Year Real EBIT: 12.84
9. Price/NCAV: 13.86
10. Price/Tangible Book: 4.53
Mattel is a toy company. It’s one of the big two. The other is Hasbro (HAS). They’re a little different. But only a little bit. At the moment – the two stocks look shockingly similar:
Mattel vs. Hasbro – Vital Signs
|Return on Capital||23.28%||21.84%|
|FCF Margin Variation||0.45||0.43|
|Return on Capital Variation||0.24||0.61|
|Price / 10-Year Real FCF||16.18||17.74|
|EV / 10-Year Real EBIT||12.84||24.13|
|Price / NCAV||13.86||(17.73)|
As you can see – both Mattel and Hasbro are financially sound. That’s what the Z-Score and F-Score measure. And if you studied the two companies yourself you’d come to the same conclusion. There’s no bankruptcy risk here.
These are both very profitable businesses. They turn almost 10 cents of every dollar of sales into free cash. And they earn high returns on tangible capital. Of course, the most important assets of any toy company are the intangibles. The brands.
Mattel owns some of the world’s oldest, best known toy brands:
· Fisher Price (79 years old)
· Matchbox (57 years old)
· Barbie (50 years old)
· Little People (50 years old)
· Hot Wheels (41 years old)
· American Girl (22 years old)
You see why the toy business is such a reliable free cash flow generator. Great new brands don’t come along very often. And old brands can continue to churn out cash. You don’t need to replace them. You just need to maintain them.
We should take a little detour here and talk about the reliability of the toy business – the consistency. Some people think toy businesses are very hit or miss. One year they’re doing great. The next year there’s no Tickle-Me-Elmo or whatever and they lose tons of money. It’s not like that at all. Even second tier toymakers – like Jakks Pacific (JAKK) – have more consistent free cash flow than most companies in most industries. Actual cash losses are pretty rare in the toy business. Profitability is not volatile. It is seasonal. Very seasonal. But I’m not sure why that matters. It’s not like there’s a risk we’ll skip winter this year and just have the spring follow fall. Seasonality is predictable. It shouldn’t make you shy away from owning any stock.
The toy business is not only a good business. It’s also a stable and reliable business.
So why shouldn’t you buy Mattel?
My argument against Mattel – and it’s not a short argument – has two parts. Part one is that the stock isn’t cheap. Part two is that it doesn’t have any special growth or turnaround characteristics that make up for part one. If a stock isn’t cheap relative to its past free cash flow it needs to have a really special future in store. And there’s no reason to think Mattel’s future will be much different from its past.
I explained some of this in my January article. But it’s worth repeating. Mattel has been spending less and less on advertising relative to its other expenses. That’s not a devastating flaw. But I don’t like it. My overwhelming preference with this sort of brand driven company is to see other costs taken out of the business and reinvested in advertising the brands.
There’s no doubt a big part of the competitive advantages Mattel and Hasbro enjoy are related to the breadth of their offerings. Great. There are synergies there. But that’s not going to drive growth. Only two things can do that. You can either get new brands or improve the brands you’ve got.
I won’t repeat the really long insufficient advertising argument I made in my January article. I’ll just say that Mattel has reduced advertising spending as a percent of sales quite a lot over the last decade. That does provide more free cash flow. Mattel’s free cash flow would be a couple hundred million dollars lower if Mattel was spending the same percent of each dollar of sales on advertising that it did in 1999. But it’s also not where I want my free cash flow gains to come from.
Now – if all this was happening to a cheap stock – you wouldn’t hear a peep out of me. If I could buy Mattel at 8 times its normal cash earning power – I’d be ecstatic whether or not they were investing in growth. But at 16 times normal earnings – you need growth. And I don’t think Mattel is going to give you growth.
This isn’t a sell recommendation. I’m not even sure it’s a hold. Mattel is a reliable, quality company. It’s one of the two big players in an industry I’d love to invest in. And Mattel’s capital allocation – outside of the actual business – has been quite good. Mattel pays a nice dividend. Over the last 5 years or so – they’ve bought back a lot of stock. I like that. I’m just not willing to pay up for it.
I know what you’re thinking.
Maybe Carl Icahn sees the same problems. Maybe Carl Icahn wants Mattel to make changes. We know Icahn isn’t shy about telling CEOs what to do.
But Mattel is a small position for Icahn right now. He owns less than 1% of Mattel’s outstanding shares. So there’s not much Icahn can do – yet. I won’t rule out the possibility of Icahn wanting to shake things up.
But I will say that Mattel seems an unlikely target. The best activist situations are ones where an extraordinary corporate event can unlock value. They’re not usually ones where you have to fiddle with the actual running of the business. Bill Ackman was successful at Fortune Brands (FO). He got them to break the company into 3 different businesses. That’s a good activist target. So is a company with idle cash. So is a company that is refusing a takeover bid.
Mattel is none of those things.
You can’t break it up. It’s already paying a nice cash dividend. Sure. The dividend could be higher. Almost any American company’s dividend could be higher. Mattel pays out less than 60% of its normal cash earnings. That’s not really very low. A lot of companies pay out less than 60%.
So I don’t see huge opportunities here. If I had to choose between buying Mattel or buying the S&P 500 – it would be a close call.
Mattel looks fairly valued.
I wouldn’t follow Carl Icahn into the stock.
The problem is price. At $15 a share – I’d happily follow Icahn into Mattel.
Mattel is a different stock from Icahn’s other new buy: Masco (MAS). Very different. Masco is a financially weak company selling for a low price compared to its normal earnings. Mattel is a financially strong company selling for an average price compared to its normal earnings.
Mattel vs. Masco – Vital Signs
|Return on Capital||23.28%||16.65%|
|FCF Margin Variation||0.45||0.22|
|Return on Capital Variation||0.24||0.50|
|Price / 10-Year Real FCF||16.18||4.39|
|EV / 10-Year Real EBIT||12.84||5.38|
|Price / NCAV||13.86||(1.43)|
|Price / Tangible Book||4.53||(4.91)|
Either stock could work out.
But I’m not ready to follow Carl Icahn into Mattel or Masco. I don’t like the price on Mattel. And Masco is a financially weak company that depends – to some extent – on decent macroeconomic conditions to hobble through.
Both stocks are better than average bets.
But neither stock is a fat pitch.