Mattel Still Unable to Capitalize on Its Brands

We stand by our narrow moat rating on

However, the firm now expects operating margins that are “significantly lower” than 2016’s 14.7%, where we had only 20 basis points of compression embedded in our model, given difficulties Mattel was lapping from last year’s fourth quarter. Culprits on the gross margin line come from mix, logistics, and lower volumes (also mentioned were higher inventory write-downs and discounts offered to clear product), while higher advertising dollars and operating expenses are likely to weigh on the SG&A ratio. With the magnitude of near-term pressure larger than we previously thought, Mattel could barely break even this year. We don’t plan any material change to our $26 fair value estimate, and view shares as undervalued, as our expectation for normalized earnings power is still well above current levels. That said, it could be a rocky road back to prior profit levels.

While our prior model had operating margins languishing below Mattel’s long-term operating margin goal of 15%, we had it reaching that level in 2022, from 5% in 2017 (which should move lower with this update), and versus a 14% average over the past 10 years. In our opinion, the long duration back to the firm’s goals compensates for the difficulty the management team still has with right-sizing the inventory base and innovating properly to connect with consumers (we expect improvement in this during 2018).

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