By David Sterman
With the economy showing new signs of weakness, profit forecasts are coming into question, especially for companies that are counting on consumer spending. But toy maker Hasbro (NYSE: HAS) laid down a path in 2008 and 2009 that should set the stage for robust results in 2012 and 2013 -- regardless of how the economy fares.
The long-term plan: sharply boost international sales and more effectively capture royalties from the company's many licensed characters and games. On the first count, the results are already in. International sales shot up 43% in the second quarter (though only 30% if the weak dollar's impact is excluded) and now account for roughly 40% of the company's entire sales mix. Look for the figure to approach 50% as the company deepens its international sales strategy.
Yet Hasbro hasn't run out of growth in the United States. Sales rose a solid 14% in North America in the second quarter, and there's reason to believe that both U.S. and international sales growth can stay robust in the years ahead. This is primarily the result of a plan to make a series of movies based on Hasbro's toys and games. The just-released "Transformers: Dark of the Moon" is just one of a half-dozen movies based on Hasbro products that will be released between 2011 and 2014. As a point of reference, Hasbro expects to sell roughly $500 million worth of Transformers toys this year, thanks to the movie's promotional tie-ins.
Yet it's the math behind the movies themselves that makes the strategy compelling. Hasbro figures that licensing its characters to Hollywood studios and elsewhere will lead royalties to account for 10% of sales by 2015. But royalty revenue carries such high margins that it should account for 30% of profits by then. This is why analysts have focused on a steadily expanding bottom line.
After hitting an economy-related lull in 2008, per share profits rebounded smartly in 2009, rose 10% in 2010 and now look set to expand at an accelerating clip. This is partly attributable to an aggressive stock buyback program that is shrinking the share count. Shares outstanding fell from 197 million in 2005 to just 139 million at the end of 2010. This number could drop below 130 million sometime in 2012. ($474.5 million remains under the current share buyback authorization, which would remove 11 million shares at current prices.) Cutting the share count by 35% over six years is a sure-fire way to boost per share profits.
So with such a solid growth outlook, why did shares drop 5% when second-quarter results were released, and why do they languish near 52-week lows? First, investors would like to see management do a better job of controlling expenses. Management counters by saying the current investments in the business are essential to boosting profits at a solid clip in coming years. For example, Hasbro has been pouring money into the The Hub, a new TV network jointly-owned by Discovery Communications (Nasdaq: DISCA). As viewership builds for the fledgling cable channel, the company's heavy investments should yield rising profits.
In addition, the impressive spike in international sales is due to ongoing investments in foreign sales offices. "Many of these investments are ahead of the associated revenue they will create while in the quarter have limited our margin expansion," noted CEO Brian Goldner on the company's second-quarter conference call, adding that "as we go forward to the full year 2011 and beyond, we believe these investments will pay dividends in revenue and profitability improvements."
Shares also took a hit when second-quarter earnings were released on slightly weaker-than-expected gross margins. Hasbro decided to write down some slow-selling inventory that was reduced for clearance. Yet looking ahead, management believes inventories are in very strong shape, no further write-downs are necessary, and gross margins should rebound back above the historical norm of 58% in coming quarters.
This is a clear case of investor myopia. Hasbro's second-quarter results were just OK, and not good enough to give the shares any lift. Yet when you look at the longer-term picture, you'll find a healthy company that's getting even healthier. In a tough consumer economy, Hasbro looks like one of the few consumer discretionary stocks capable of meaningful profit growth.
Looking for timeliness? Hasbro is now entering into the seasonally-important second half of the year, when the company typically earns up to 80% of its annual profit. This should be especially pronounced this time around because the company is launching a pair of new toy lines: construction-oriented toys (known as Kre-O) and toys based on the TV show Sesame Street.
As a solid and consistent grower, Hasboro deserves to trade up to the around 14 or 15 times forward earnings (2012 of around $3.50), which translates into a share price of $50 or even the low $50s. This is more than 25%-30% near-term upside, but I think it's a solid stock to own for the long haul.