With some economists even predicting a double dip, companies specialized in consumer goods are well positioned to appreciate off of a low bar. Employment figures and recovery may be sluggish, but the stock market pessimism is unwarranted in some instances. In this article, I will run you through my DCF model on Mattel (MAT) and then triangulate the result with a review of the fundamentals against Avon Products (AVP) and Activision Blizzard (ATVI). I find Activision and Mattel substantially undervalued given strong secular trends in recreation for the youth.
First, let's begin with an assumption about the top-line. Mattel had $6.3B worth of revenue in FY2011, which represented a 7% gain off of the preceding year. Analysts model a 9.1% per annum growth rate over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 49.8% of revenue versus 31% for SG&A, 3% for R&D, and 2.6% for capex. Taxes are estimated at 18% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around 2% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 3% and discounting backwards by a WACC of 8% yields a fair value figure of $45.06, implying nearly 40% upside. Mattel is thus a quality brand with a quality 3.8% dividend yield at a quality price.
All of this falls within the context of management strongly focusing on growth:
"We continue to see growth internationally. For the quarter, we saw growth across all regions. Our Latin American business is doing particularly well as it has for the last few years. And our European business continues to perform well, despite the stiff economic challenges there, gaining NPD share through February".
From a multiples perspective, Mattel also appears cheap. It trades at a respective 14.9x and 12.2x past and forward earnings versus 23.2x and 16.8x for Avon and 13.9x and 11.9x for Activision.
Consensus estimates for beauty purveyor Avon's EPS forecast that it will decline by 37.2% to $1.03 in 2012 and then grow by 20.4% and 12.9% in the following two years. Assuming a multiple of 16.5x and a conservative 2013 EPS of $1.18, the stock would be roughly fairly valued. The company recently received a takeover bid, which I predicted at the right price, and promptly rejected it. Given the bribery charges and failed execution by management, a corporate shakeup would help create some, although not tremendous, value at this point.
Consensus estimates for game maker Activision's EPS forecast that it will grow by 4.3% to $0.97 in 2012 and then by 10.3% and 15.9% in the following two years. Assuming a multiple of 16.5x and a conservative 2013 EPS of $1.03, the stock would hit $17 for 33.4% upside. Many investors are on the sidelines due to World of Warcraft churn, but the company still has delivered impressive execution in other titles, like Skylanders. Accordingly, the Street rates the stock around a "strong buy" (source: NASDAQ).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.