Mattel Downgraded on Increasing Costs

Jun.22.10 | About: Mattel, Inc. (MAT)

We recently downgraded our rating for Mattel Inc. (NASDAQ:MAT) from Outperform to Neutral, primarily due to escalating input costs, an adverse impact of a weakening euro and continued weakness in the global economy.

First-Quarter Results Ahead of Estimates

Mattel’s first-quarter earnings of 7 cents per share were ahead of the Zacks Consensus Estimate for a loss of 2 cents per share.

Worldwide net sales for the toy company increased 12% from the prior-year quarter to $880.1 million. Both U.S. and international gross sales increased 12% year over year. Gross margin was 49.1%, up 510 basis points from the prior-year period.

The better-than-expected results were primarily driven by strong sales of its core brands. The company is also focused on controlling expenses.

Outlook for 2010

Management emphasized that raw material cost pressures and rising Chinese labor rates will pose challenges to gross margin in the second half of 2010, but it will be partially offset by some price increases.

Management expects to reduce costs in the range of $180 to $200 million and is on track to deliver the same by the end of fiscal 2010.

Downgraded to Neutral

We believe Mattel’s ability to deliver growth in both revenue and earnings per share is based on broad-based strength across the company's core brand product portfolio and benefits from cost containment. Moreover, Mattel has an industry leading position, a strong balance sheet and a solid product line. Its focus on top-line growth, margin expansion and cash conservation also bodes well.

However, Mattel faces raw material cost pressures. Plus, an increase in labor cost may further pose a drag on the stock. It will also likely face foreign currency headwinds during the second half of 2010 primarily due to a weakening euro.

Additionally, competition from private label toys and the video game industry is increasing. Furthermore, the toy business is seasonal, with a large percentage of revenue, earnings and cash flow coming from the holiday season in the fourth quarter of a year. Therefore, we are downgrading the stock from Outperform to Neutral.