UBS Answers 5 FAQs From Investors About Mattel

The toy industry is experiencing turmoil. As recently as this month, Danish toymaker Lego announced job cuts, as its sales for the first half declined for the first time in a decade.

Also this month, Toys R Us reportedly hired restructuring lawyers for potentially filing for bankruptcy.

However, Mattel, Inc. MAT and Hasbro, Inc. HAS ringed in fairly solid second-quarter results. Against this backdrop, UBS addressed five frequently asked questions regarding Mattel and provided its answers for these concerns.

The firm has a Buy rating on the shares of Mattel and a $23 price target.

1. Ability To Re-Negotiate Debt Covenant

Analyst Arpine Kocharyan sees the Toys R Us announcement as signaling a softer holiday season. Even if a Chapter 11 scenario occurs, the analyst feels it will be only after the critical November-December period.

Meanwhile, the analyst noted that Mattel's renegotiation of its debt covenant is a third-quarter issue, since by the year's end, debt to EBITDA ratio has to be below 3.75 times, given the working capital needs and cash flow cycle.

Although the Toys R Us development is near-term disruptive, the analyst doesn't think it will have a long-lasting impact on the toy sector. The analyst expects Mattel to complete its renegotiation over the next 10–15 days, with the 8k filing expected in that timeframe.

2. Mattel CEO Commitment

UBS thinks the market will question the turnaround commitment of new CEO Margaret Georgiadis, particularly given the stock's performance and the uncertain back half of the year.

The firm feels some recent senior management changes wouldn't have happened if there was no long-term commitment by the CEO. The firm also noted that the CEO has purchased stock in the open market in early August, separate from comp stock vesting.

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3. 'Cars 3' Shortfall

UBS said the second quarter "Cars" revenue of $120 million was borrowed partially from the third quarter. Therefore, the firm believes the third quarter will come in below the $100 million range.

The firm said the franchise performance of Walt Disney Co DIS's "Cars" at the box office did not meet its own expectations.

"So we believe any commitments under master toy license have to be viewed within overall franchise performance, not just what MAT has committed to delivering under the license," the firm said.

4. Attainability Of Back-Half Growth

The firm indicated that the low-single-digit percentage sales growth guidance for 2017 implies second half growth of 7 percent or $250 million in sales growth from last year. With the firm expecting $130 million–$140 million contribution from "Cars," it said the underlying business should grow in the low-single-digit percent range.

UBS noted that historically, Mattel's fourth-quarter sales account for 34 percent of the total sales compared to 33 percent in the third quarter. Given that Mattel has guided the fourth quarter to be higher than the five-year average, probably in the 36 percent range, UBS said the third quarter growth guidance would be in the 3–4-percent range and that for the fourth quarter at 9–10 percent.

5. Near-Term Spending On Reinvestment

UBS believes uncertainty around what Mattel needs to spend near term and how that incremental spend flows through opex vs. capex has been a key factor preventing the stock from finding a floor.

The firm expects answers for this question during the third quarter call, given the recent senior management changes, including the hiring of a new CTO in mid-July, and the board meeting held at the end of August.

Related Link: Hasbro Vs. Mattel: Which Was The Better Toy Story In 2016?