Toying With Mattel: Recall Problem Should Soon Correct

One of the keys to long term investing is to buy steady cash flow businesses when they have taken a beating, primarily as a result of some short term problem around them. Once the storm created by this problem passes, the market will start valuing the business at its fair value leading to nice gains for an investor.

In the past few months, toy company Mattel Inc. (MAT) has had such problems swirling around it. It all began with excess levels of lead being found in paints that are used in some of Mattel's products. This led to successive recalls of a large number of toys. This surely dented Mattel's image as a toy maker and also cost the company millions in damage control, recalls, supply chain disruptions, etc.

The company has been fairly upfront on the steps they have taken to control the damage. They have put in place inspections of their suppliers in China and have also increased the frequency of random inspections of their products. At the height of the recall, the company had stopped accepting products from its suppliers and sub-contractors for some time, leading to supply chain disruptions.

Mattel's stock has taken a beating of almost 30% due to this event. In the Q3 2007 earnings report Mattel has taken a charge of $40 million as a fallout of the recalls. Apart from the charge, the business is generating steady cash flows. One of the big positives of the company's business is that almost half of its sales are from outside the United States. This means that these foreign sales should grow at a faster pace due to the fast growing economies in developing countries. It also gives an investor a hedge against the falling dollar, since the foreign sales are worth more in dollar terms.

Global supply chains are a irreversible reality in today's manufacturing world. Making of toys is no exception. Since, manufacturers in developing countries do not have to fear lawsuits as much as they do in USA or Europe, these issues are not very surprising. And companies are going to have to learn to overcome these setbacks, by tightening inspections and controls over their contractors and sub-contractors.

But most importantly, in case of Mattel, the toy recall is a short term problem. The company has taken steps to fix it and eventually the problem will become a distant blip on the radar. And thats when the market will start valuing the company at its fair value, leading to nice gains. The dividend yield at the current stock price of $21 is more than 3%. Not a bad compensation if you are willing to wait till the stock starts trading at fair value.

Disclosure: Author has no position in Mattel.

Comments

[stockinvestor]

Worst isn't over.... MAT has issued two more recalls today (Nov 7, 2007). Reports are aplenty about toys shortage for holiday season. I agree with author's view on buying MAT for long term, but the stock hasn't hit bottom.... I'll wait for another month until the dust settles.