By The Valuentum Team
Hasbro (NASDAQ:HAS) operates in a competitive industry, and 'the next big thing' is constantly being hunted by developers across its industry group. We like what the firm's strategic merchandizing relationship with Disney (NYSE:DIS) does for the stability of its product offerings in the coming years, but the upside of such a relationship is tied to big-name movie releases, which has the potential to result in inconsistent results. But that may just be icing on the cake in some ways.
Recent performance of Hasbro's franchise brands has been strong, where operating profit margins are greater than the company average, and the ongoing focus on its high margin 'Entertainment & Licensing' segment should continue to push overall margins higher. Continual investment (~5% of total revenue) in product development is expected to continue to drive demand for its innovative products. Additionally, the firm expects to continue to benefit from global expansion, which includes industry growth in markets in which it is already established around the world.
Hasbro's dividend history is a strong one, despite having cut its payout in 2000. It has paid a dividend since 1977 and has increased its quarterly payout in 12 of the last 13 years. The dividend has a solid yield of more than 2.5%, and the firm's Dividend Cushion ratio is a promising 1.7. We're not too concerned with the company's ~$1.7 billion total debt position as of the end of 2015, as cash and cash equivalents of more than $975 million and strong free cash flow generation should be more than able to handle the load. All things considered, we like Hasbro's dividend growth prospects.
Hasbro's Investment Considerations
• Hasbro's products include toys/games, television programming, motion pictures and digital gaming. The firm owns well-known brands such as Transformers, Nerf, Playskool, My Little Pony, G.I. Joe, Magic: The Gathering, and Monopoly. The company was founded in 1923 and is headquartered in Rhode Island.
• Though concerns over the demise of physical toys may not be completely unfounded in this digital age, Hasbro is less a toy company than it is a licensing firm. Its high-margin entertainment and licensing segment operating profit has grown at a tremendous rate as of late.
• Hasbro is focused on re-igniting its world-class portfolio of brands. The company is targeting a long-term revenue CAGR of 5%, operating profit to exceed revenue expansion, and operating cash flow to average roughly $500 million annually. It plans on using this cash to invest in the long-term profitable growth of the firm, return excess cash to shareholders, and maintain an investment grade credit rating.
• Hasbro's strategic merchandising relationship with Disney Consumer Products for the Disney Princess and Frozen properties is a huge win, and we expect the company to benefit from the relationship for years to come. The potential for quarterly results to be tied to the release of big-name movies and corresponding products should be recognized by investors.
• We're big fans of Hasbro's dividend growth potential. The company has been paying dividends since 1977, and it appears that dividend increases are on the horizon. The firm has intentions to continue to buy back a significant amount of stock.
Economic Profit Analysis
In our opinion, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.
The gap or difference between ROIC and WACC is called the firm's economic profit spread. Hasbro's 3-year historical return on invested capital (without goodwill) is 37.3%, which is above the estimate of its cost of capital of 9.9%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Hasbro's free cash flow margin has averaged about 8.1% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Hasbro, cash flow from operations increased about 38% from levels registered two years ago, while capital expenditures expanded about 27% over the same time period.
We think Hasbro is worth $73 per share with a fair value range of $58-$88.
The margin of safety around our fair value estimate is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 5.4% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 2.8%.
Our model reflects a 5-year projected average operating margin of 16.8%, which is above Hasbro's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.8% for the next 15 years and 3% in perpetuity. For Hasbro, we use a 9.9% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $73 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for Hasbro. We think the firm is attractive below $58 per share (the green line), but quite expensive above $88 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Hasbro's fair value at this point in time to be about $73 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Hasbro's expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $93 per share in Year 3 represents our existing fair value per share of $73 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.