Hasbro: Further Downside May Be Ahead
- In today's article we will be valuing Hasbro's stock using dividend discount models.
- We will estimate and discuss the implied dividend growth rate, which would justify the current market price on the stock.
- We will consider two scenarios, which we believe may be realistic in the current macroeconomic environment, and also calculate the fair value for these cases.
Hasbro, Inc. (NASDAQ:HAS), together with its subsidiaries, operates as a play and entertainment company. So far, we have written two articles about Hasbro's stock, first giving it a neutral rating, an later downgrading it to "sell", due to the weaker than expected holiday sales, the growing inventory levels and the uncertainty regarding the sustainability of the dividend.
While in the previous articles we have been primarily looking at macro- and microeconomic factors that impact Hasbro's business, today we have decided to take a different approach. Today we will try to estimate the fair value of Hasbro's company based on its dividends and its expected dividend growth.
First, we will estimate, what is the current expectation by the market, what is the implied dividend growth based on the current share price. The we will be using scenario analysis to see, what price could be justified for different assumptions with regards to growth.
To answer all these questions, we will be using dividend discount models. But before we start, we have to discuss, why exactly we chose this approach, why we believe it could be suitable, and what the drawbacks are.
Dividend discount models
As Hasbro's price has fallen significantly in the past 12 months, its dividend yield became quite high, 5.8% to be precise. Such a high yield often catches the attention of dividend and dividend growth investors and for this reason, we decided to evaluate the firm today based solely on its future dividend payments.
Dividend discount models (DDM) help to determine the fair value of a company by discounting the future dividend payments. These models could be suitable for valuing firms that have shown strong commitment of returning value to their shareholders in the form of dividend payments. Stable and sustainable dividend growth over a long period of time is always a good indication for this. Hasbro fulfills this criteria.
Hasbro has been paying dividends for its shareholders each year in the past 33 years. While they have not always managed to increase these payments, between 2005 and 2020, the payments have increased significantly.
One drawback of the model is that it is more suitable for firms that are relatively unaffected by the fluctuations of the business cycle. Hasbro, as a firm operating in the consumer discretionary space, is likely directly impacted by business cycle and consumer sentiment, which in turn may also influence the dividend policy. But to account for this, we will be using scenario analysis.
Now that we understand that Hasbro may be a suitable candidate to be valued by DDMs, we have to highlight the primary assumptions that go into such models. These are: required rate of return and the dividend growth rate assumption.
For our calculations, for all cases, we are going to keep the required rate of return the same, namely 11%. This corresponds to the firm's weighted average cost of capital (WACC).
Implied dividend growth rate
Implied dividend growth rate is the growth rate that would justify the current market price. Currently, the firm is paying an annual dividend of $2.8 per share. If we assume a dividend growth rate of 5.1% in perpetuity, we would get a fair value close to the current market price of $48 per share.
We believe that this implied growth rate is too high. To explain why, we have to take a look at the firm's dividend growth history.
Even the 10Y dividend growth rate of the firm is 4.9%, slightly below the 5.1% implied by the market. But the 4.9% is still significantly above the growth rate that the firm has managed to achieve in the past 3 - 5 years. Further, the firm's payout ratios are not particularly pointing to dividend safety, and for these reasons, we believe that it is better to look at different growth scenarios, which may be more realistic.
For this scenario we will assume that the dividend will grow at a rate of 2.5% in perpetuity, which is about in line with the overall growth of the economy. The estimated dividends using this method are essentially not far away from the consensus dividend estimates by analysts for the next couple of years.
The results are shown in the table below, indicating a firm value of $33 per share, representing a further 30% downside from the current price levels.
This, however we believe is a relatively pessimistic approach. We believe that the near term macroeconomic headwinds are likely to improve in the coming years, which could also positively influence Hasbro's financial performance and in turn its dividend growth. Improving consumer confidence, slowing inflation and the decreasing energy prices could all have a positive impact. The question is, when and will Hasbro be able to sustain the dividends until then?
To try to answer this question, we have created another scenario.
For this scenario we assume that Hasbro will suspend its dividend for one year, due to the macroeconomic headwinds. After resuming the dividends, however, we assume that they would initially grow the payments rapidly and then gradually declining to a perpetual growth rate of 3%.
These assumptions yield a fair value of $38 per share, which is still about 20% below the current price.
While many of the traditional price multiples indicate that Hasbro is about fairly valued/ slightly undervalued, we still believe that there is further downside potential.
To sum up
We believe that the uncertainty regarding the macroeconomic environment is still relatively high. Although we have seen improvements in the past quarters in terms of consumer confidence, energy prices and inflation, however there is still a long way to go, to reach normal levels.
The current dividend growth rate implied by the market price appears to high, based on the historic dividend growth rate and on the macroeconomic uncertainty.
There may still be substantial downside ahead for the stock based on our calculations, and for this reason, we do not feel comfortable with adding Hasbro stock to our dividend portfolio at the current levels.
This article was written by
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