Mattel Suffering From The China Syndrome

China can be dangerous to your family’s health if you feed your pets, brush your teeth, drive your car or give toys to your children or grandchildren (and of course so can the U.S. if you ate certain spinach, or Japan if you drove some SUVs with some of their tires). Of interest to investors may be the way China can be dangerous to your portfolio.

China stocks have been red hot lately, and that has generally been good for the adventurous who invested there, particularly in funds such as iShares FTSE Xinhua 25 Index (FXI). In addition, major companies that directly sell to or in China (like MacDonald’s - MCD), or export from China (like WalMart (WMT)), have benefited greatly in many cases. However, in a wonderful illustration of the utility of diversification and the unpredictable risks associated with owning a limited number of individual stocks, Mattel (MAT) has been severely injured by its China connection.

Since its long-time price peak in April, MAT has lost about 25% of its value under the pressure of China-made toy recalls due to lead paint that can poison children and buttons that can choke them. At the same time, the China stocks basket, FXI, has risen about 40%.

MAT may have more decline to go by the way. The recalls don’t seem to be over. The financial reports relating to the recalls are not out yet. The impact of the all important Christmas selling season is not yet known, although it probably won’t be favorable.

MAT has had more dramatic declines than its current decline, so historical patterns suggest that the stock price damage will not be contained. The technicals don’t look so good. See this price chart from 1994 forward.

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The company has a Dec. 31 fiscal year-end and is totally second half loaded when it comes to profits. For example, in 2006 the first half produced $0.18 in profits while the second half produced $1.37 in profits. For 2007, the first half produced $0.18 in profits and one leading research organization estimates $1.46 for the second half.

The current dividend is $0.65 which is an attractive rate, but that payout would be quite a burden after a bad Christmas season. They have reduced dividends dramatically in the past and would surely do so again if profits did not materialize reasonably as expected (dividends were cut from $0.34 to $0.05 from 1999 to 2001, for example).

We sure wish them the best and think of them fondly as suppliers of many toys of our childhood, but we don’t know any safety conscious moms who will be buying their toys this year. If careful young mothers won’t smoke or drink or eat sushi during pregnancy, why would they buy toys that might choke or poison their children to death?

Mattel has an enormous brand equity problem on their hands that may be more serious than the Tylenol poisoning crisis of 1982. Johnson & Johnson (JNJ) handled their problem brilliantly, but they had financial strength, market strength, manufacturing and sourcing controls and management capability that Mattel may not have.

Certainly, Mattel does not have control of its manufacturing the way JNJ had. We hope Mattel can resolve this problem and restore confidence, but with China as a source, we don’t know how they can do it. China can’t turn around their broken quality control systems before Christmas.

Disclosure: Author does not own any stock named in this article