Justin Sullivan
Overview
My recommendation for Hasbro (NASDAQ:HAS) is still a hold rating as the demand environment remains weak, and I am not confident that this situation will be resolved anytime in the near term. Even if I had the confidence, I would only take action when HAS reported strong positive results. That said, I am looking forward to seeing gross margin expand ahead, which is one of the two things that I expect must happen for the stock to be rerated upwards. Note that I previously rated a hold rating for HAS, as 3Q23 saw no improvements at all. Contrary to this, revenue saw a further decline, which triggered management to revise its FY23 guidance downward.
Recent results & updates
HAS reported its 4Q23 results close to a month ago, and it took me a while to fully grasp the situation that HAS is in today and what to expect ahead. As expected from the revised FY23 guidance, 4Q23 was not strong. Revenue came in at $1.29 billion, falling by 23% vs. 4Q22 and missing consensus expectations of $1.32 billion. HAS also missed on adj. EBITDA, reporting $11 million vs. consensus of $219 million. Consequently, EPS also missed, coming in at $0.38 vs. expectations of $0.62. Overall, a very sluggish performance.
Clearly, there were no signs of recovery strength at the topline at all. In fact, 4Q23 POS (point-of-sale) performance was weaker than the year-to-3Q23 performance (-8% revenue growth), as POS was down 12-13% in the quarter. This was a horrible performance, as 4Q23 was supposed to be a strong year for HAS because of the holiday season. Moreover, 4Q22 was an easy comp due to the inventory reduction efforts by retailers. This simply shows how weak the consumer demand environment is. With inflation remaining sticky and the entertainment slate being relatively quiet in 2024, my view is that the toy industry will continue to face pressure in the near-term. This is pretty much in line with management expectations that the toy industry will remain soft in 2024. Another reason that got me to think that pressure on growth will persist is that the retail industry’s inventory levels remain high with old and heavily discounted inventories (which means higher likelihood of promotions that could force HAS to do so as well). As such, I remain pessimistic about the FY24 growth outlook. It is also unlikely that the market will look beyond FY24 either (i.e., price in a recovery), given that management is guiding consumer products segment [CP] revenue to be down 7–12%, with steeper declines in 1H24 (in line with 2H23’s results, which were down 20–25%). Although management is expecting stabilization in 3Q and a return to growth in 4Q, I just don’t think any investors are going to stick their heads out to take a confident view that growth will recover given the state of the consumer demand environment.
Retailers ended the year with inventory down high-single digits as measured in both dollars and weeks of supply. While they made significant progress in 2023, retailer inventories remained slightly elevated compared to historical norms. MAT 4Q23 earnings call
We’re exiting 2023, with our retail inventory down around 20%. While we think Hasbro’s retail inventory is in a healthy position, across the industry a lot of older discounted inventory still remains in the market. HAS 4Q23 earnings call
If I were to look over the medium term, the area I am monitoring is margin expansion (assuming that consumer demand will eventually recover). Although the gross margin decreased by about 820bps in 4Q23, HAS should see an improvement due to a 50% reduction in the number of SKUs (which lowers the cost of inventory management) and a decrease in discount pressure as the industry gets rid of its surplus of inventory (overtime). On the inventory situation, while the industry inventory level was elevated, it was encouraging to know that HAS owned inventory levels are down by more than 50% vs. last year and retail inventories are down 20%. The important thing to remember is that management pointed out that all of their owned inventory is accompanied by a purchase order, which implies there is no need to give discounts that will eat into growth and margins (important to note that this is for current inventories and not incremental inventories). Hence, my view is that HAS is “ahead” of the industry in this aspect, but the positive impacts will only be seen when the industry inventory level eases.
Management is also accelerating the savings program. Specifically, the goal for gross savings was increased from $350–400 million to $750 million. In 2024, management expects $250 million in savings, with half of that amount going into the P&L statement. I think this target is plausible given that there are a number of measures that management is going to implement (aside from reducing SKUs). These include improving supply chain forecasting to keep owned and retail inventory within desired thresholds, implementing zero-based budgeting to stem overhead deleverage, and working on pricing precision and execution with retailers.
Valuation and risk
Author’s valuation model
To be honest, at this point, the best guess on what HAS is worth in the near term is simply to rely on management guidance. Using the FY24 guide, I got a target price of $52. I used management FY24 adj EBITDA guidance and my assumption of a 50% EBITDA to earnings conversion ratio (in line with the past 2 years) to derive $481 million in earnings for FY24. The market is currently valuing the stock at a 15x forward multiple, a 2-turn increase from the last time I valued the stock. While the outlook is murky, I think HAS deserves credit in that it has managed its own inventory situation really well, suggesting that it does not need to resort to further discounts to clear its inventories.
Overall, I think the stock is going to be rangebound until we see 2 things: (1) return in top line growth driven by a recovery in industry demand; (2) clear margin expansion that indicates HAS is officially off the hooks of the inventory surplus pressure.
Summary
I am sticking with a hold rating for HAS for now. The near term outlook remains uncertain due to weak consumer demand and elevated industry inventories. The positive aspect is that HAS has significantly reduced its own inventory, which means it does not need to implement significant discounts, which will impact margins. Management is also actively implementing margin improvement initiatives (either to cut cost or to improve productivity). All in all, I’ll be keeping a close eye on two key metrics: a rebound in top-line growth and clear margin expansion. These will signal a potential buying opportunity for HAS down the road.
