Image Source: William Warby
Simulated Dividend Growth Newsletter idea Hasbro turned in another lackluster quarterly report, but its second-quarter results were better than expected as the company continues to work through a variety of what it believes are transient issues.
By Kris Rosemann
Hasbro (HAS) continues to face obstacles in the form of the liquidation of major customer Toys ‘R’ Us in the US and other key markets and a rapidly evolving European retail landscape, but management continues to expect to return to growth in 2019 as it adapts to the changing operating environment in Europe and fills the consumer demand void created by the departure of Toys ‘R’ Us, “Toys ‘R’ Us Liquidation News Transient to Toy Makers.” We expect Hasbro to remain an idea in the simulated Dividend Growth Newsletter portfolio for the time being, and it brings with it a ~2.4% yield and 2.1 Dividend Cushion ratio. Though the quarter didn’t look great at a high level, we expect to increase our fair value estimate from better margin projections thanks to the ongoing strength of its higher-margin ‘Entertainment and Licensing’ segment and a slightly lower cost of capital assumption.
The simulated Dividend Growth Newsletter portfolio idea’s second quarter 2018 results, released July 23, revealed a net revenue decline of 7% on a year-over-year basis. Revenue in the ‘US and Canada’ segment fell 7% from the year-ago period, while a 16% decline in Europe led ‘International’ segment revenue down 11% from the comparable period of 2017 due to the loss of Toys ‘R’ Us revenues and efforts to move excess retail inventory in Europe. The ‘Entertainment and Licensing’ segment was the lone bright spot in the quarter as it grew revenue by 26% year-over-year, but it still only accounts for just over 7% of total revenue.
Hasbro’s operating profit margin was also impacted by its top-line pressures in the second quarter of 2018 as it fell to 9.7% from 10.3% in the second quarter of 2017. Fixed cost deleveraging in its ‘International’ segment was a primary driver of the contraction as product mix helped offset lower top-line results in its ‘US and Canada’ segment and the ‘Entertainment and Licensing’ segment continued to impress with 64% increase in operating profit. The segment’s operating margin was a robust 28.8% (up from 22% a year earlier, thanks in part to new revenue recognition standards), and it accounted for more than 21% of total operating profit in the quarter. Net earnings per share took a step back to $0.48 in the second quarter from $0.53 in the same period of 2017.
Hasbro’s challenges have made their presence known on the company’s cash flow statement in the first half of 2018 as substantially lower net earnings through the first six months of the year led to a 34% year-over-year drop in cash provided by operating activities to $241 million. Free cash flow in the period fell to $169 million from $300 million in the first half of 2017, but the cash flow generated was sufficient in covering the $150 million in cash dividends paid in the first two quarters of 2018. The company held a reasonable net debt position of $555 million as of the end of the quarter.
We tend to agree with management’s sentiment that a return to growth should be in store for Hasbro as it works through these issues that are beyond its control. New consumer points of distribution across brick-and-mortar retail, including a greater emphasis on toys at Target (TGT), and at online marketplaces, namely at Amazon (AMZN), will eventually allow it to replace business lost from Toys ‘R’ Us, in our view, and we generally have confidence that management will be able to effectively ‘right the ship’ with respect to its retail inventory issues in Europe. We love to see the ongoing strength of its ‘Entertainment and Licensing’ segment, which we view as a key driver in the future trajectory of Hasbro’s business, but the company remains tied at least in part to physical toy demand. Nevertheless, we expect this idea to continue generating income for shareholders and are looking forward to what should be a return to growth in 2019.
Related: MAT
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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.