Toy giant Hasbro turned in a poor first-quarter report April 23, but the market is not overreacting as the issues weighing on its performance are largely transient, in our view.
By Kris Rosemann
Simulated Dividend Growth Newsletter portfolio idea Hasbro’s (HAS) first-quarter 2018 results, released April 23, weren’t great as the liquidation of Toys “R” Us in the US and UK and retail inventory overhang in Europe weighed on its top line. The issues impacting its business are not reflective of the underlying health of the business, in our view, and the market has largely recognized this view, too, with its share price moving meaningfully positive intraday April 23 following a fairly considerable premarket dip. Management continues to expect 2018 to be a challenging year, however, as it works to put the short-term disruption of the Toys “R” Us situation behind it and accelerate plans to transform its business for the evolving retail environment. The company expects to drive growth in 2019 and beyond.
Revenue in Hasbro’s ‘US and Canada’ segment fell 19% in the first quarter on a year-over-year basis, while net revenues in Europe dropped 28% from the year-ago period. A net loss of $112.5 million reported in the quarter includes after-tax expenses of $61 million related to the Toys “R” Us liquidation, ~$16 million in severance costs related to the acceleration of the company’s commercial organization transformation, and a net charge of nearly $48 million related to US tax reform. Once again, these are not recurring issues, and we do not expect net losses to become a typical occurrence at Hasbro.
The company’s attractive ‘Entertainment and Licensing’ segment, which we view as a key driver in the future trajectory of Hasbro’s business, turned in revenue growth of 21% on a year-over–year basis in the first quarter and slightly higher growth in operating income as its operating margin expanded slightly to 21.7%. Company-wide operating margins typically run in the mid-teens and came in at 15.6% in full-year 2017, well below the ‘Entertainment and Licensing’ segment’s margins.
Though the net loss at Hasbro impacted its operating cash flow generation, and ultimately free cash flow, in the first quarter, free cash flow of ~$290 million was sufficient in covering cash dividends paid as well as an uptick in share repurchases. The company is well on track to hit its goal (and may exceed its goal as it was about halfway there after one quarter) of $600-$700 million in operating cash flow in 2018. Its balance sheet remains a non-concern as its total debt of just over $1.7 billion slightly overshadows its $1.6 billion in cash and cash equivalents on the books.
All things considered, we were happy to see the market not overreact to Hasbro’s weak quarter, which, in our view, was largely expected, and we continue to include the idea in the simulated Dividend Growth Newsletter portfolio. Free cash flow coverage of the dividend has been solid of late, and we expect management to continue raising the payout (it has hiked the dividend in 14 of the last 15 years, with the lone exception being 2009).
That said, we’re keeping an eye on M&A rumors that have suggested Hasbro may be targeting a tie-up with rival Mattel (MAT). A buyout of Mattel may not be the worst case scenario for Hasbro shareholders, but if the company levers up in a meaningful way, capital allocation priorities may shift and income-oriented investors will need to carefully consider the implications. The company’s Dividend Cushion ratio is currently a healthy 2.1, and shares yield ~3% as of this writing. Shares look fairly valued and are trading just shy of our fair value estimate of $87 per share.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.