The bankruptcy and liquidation of Toys "R" Us has
created considerable disruptions for toy makers Hasbro (HAS 86.60, -3.65, -4.04%) and Mattel (MAT 15.18, +2.82, +22.82%)
over the past year. Toys "R" Us represented about 10% of revenue for
HAS in FY17, and about 8% for MAT. For both of these companies, Wal-Mart (WMT 95.59, -1.14, -1.18%)
is actually a much larger customer.
That said, MAT has also been more proactive in terms of reducing its cost structure in the face of this challenging environment, and, its core brands have held up better, especially in Europe. HAS, meanwhile, which has struggled mightily in that market.
This combination of a highly effective cost savings program, which is running ahead of schedule, and the resilient performance from its "Power Brands", as MAT calls them, led to Q4 profit that blew out analysts' expectations. Although the Toys "R" Us bankruptcy created a significant headwind, reducing MAT's gross sales by 8% in Q4, the company was in good position to withstand this turmoil in the toy industry.
"Power Brands" and Structural Changes Drive MAT's Results
After the close last night, MAT reported Q4 EPS of $0.04, easily beating the ($0.18) consensus. Revenue was down 5.4% to $1.52 bln, also comfortably ahead of the $1.44 bln expectation. As we alluded to above, there were a couple key catalysts to its better than expected results.
On the demand side, its key brands held up remarkably well. Barbie worldwide gross sales jumped by 15% for both the quarter and the year, while Hot Wheels sales were higher by 12% in Q4 and 9% in 2018. Considering that the global toy industry declined by 2% in 2018, that performance is quite impressive.
Regionally, gross sales were down 10% in North America, driven by a 17% negative impact from Toys "R" Us, while gross sales in its international segment fell by 2% in constant currency. The slowing economy in China is yet another obstacle facing MAT, which was responsible for a negative 4% impact to sales. Overall, though, the macroeconomic slowdown in China isn't as concerning as it is for many large, global companies as revenue from the entire APAC region is about 10% of the total.
A major bright spot for the company was Europe -- its second largest market at 26% of revenue -- where gross sales were actually higher by 1% in the quarter. This is in stark contrast to HAS' revenue which plummeted by 24% in 2018.
While MAT's brands withstood this storm in the toy industry well, it was its cost savings program that really made the difference in terms of profitability and better results than HAS.
In 2017, MAT began to implement a "Structural Simplification" program. Its goal was to eliminate $650 million in net costs over a two year span by right sizing its workforce (it eliminated 2,200 jobs last July), reducing SG&A expenses, cost of goods sold, as well as improving efficiency in advertising.
During the earnings call last night, management stated that it is tracking ahead of its goal as it achieved $521 million in cost savings exiting the year. That puts it on pace to exceed its overall target of $650 million in savings exiting 2019. As a result of these efforts, MAT's gross margin shot up to 46.6% from 30.7% in the year ago quarter. In fact, that was the company's first gross margin improvement since 2013. Furthermore, this vast improvement in margins drove its Q4 EPS to a surprise profit of $0.04 compared to a loss of ($0.72) in the year ago quarter.
Toys "R" Us Liquidation, Softness in Europe Hits HAS
Before the open this morning, HAS reported Q4 EPS of $1.33, missing the $1.68 consensus by a wide margin, with revenue falling 13% (compared to 5% for MAT) to $1.39 billion compared to the $1.53 billion expectation. Its franchise brands as a whole were down 8% in the quarter.
During the earnings call this morning, HAS explained that not only was it hurt by the closing of Toys "R" Us stores, but, the liquidation of inventory sold into the market at large discounts had an even larger effect than it had anticipated.
This event also had a ripple effect throughout Europe (25% of FY17 revenue), which compounded the negative factors stemming from the political volatility in the U.K surrounding Brexit. One of its key goals for this year is to stabilize business in Europe, and then look for growth beyond 2019.
Another headwind facing HAS was that it was lapping a strong year in its partner branded business, which led to yr/yr declines in Star Wars, Trolls, and Disney Princess line-ups. The good news, though, is that 2019 and 2020 are shaping up very well in this area with the upcoming Star Wars Episode 9 and Disney's Frozen 2. Additionally, the launch of new Star Wars theme parks in Orlando and Anaheim figure to provide another boost for HAS late this year and into 2020.
On the cost side, HAS has been carrying out its own program, but it is nowhere near as extensive as MAT's. It has identified cost savings of $70-$80 million by 2020 as it streamlines the business, cuts costs, and diversifies its sourcing. The company is also focusing more on its digital channel and online point of sales (including at Amazon), in order to offset some of the weakness seen on the brick-and-mortar side.
The Toys "R" Us bankruptcy and liquidation has created some havoc and headaches for both of these companies. That was expected. What wasn't expected, however, was the extreme and rapid improvement in MAT's bottom line performance in the face of these topline pressures. The impressive outperformance of its core brands puts MAT's resilience in the spotlight; while the fact that its substantial cost cutting efforts are ahead of schedule shows solid execution. HAS brands did not hold up as well as Toy's "R" Us inventory was liquidated, and its cost cutting program is not nearly as extensive.