Hasbro Stock Is Tightening Its Belt (NASDAQ:HAS)

Thesis

I have been a fan of strategy games since I was very young. I have been playing Magic: The Gathering (MtG) since 1995, and Dungeons & Dragons (D&D) since around 1998. This means that I have been a consumer of these high quality products for more than 25 years. Up until recently, Hasbro, Inc. (NASDAQ:HAS) has been a responsible steward of these IP’s since they were acquired and has made excellent decisions which have preserved their longevity.

However, in December I heard that Hasbro fired 1,100 employees and am now starting to lose faith in the competency of management. I believe this entire situation is primarily due to Disney (DIS) having such a poor showing at the box office in 2023 that their ancillary toys and action figures went undersold this most recent holiday shopping season.

Meanwhile, in 2023 the MtG development team produced the second most popular set in the games entire history, and the Baldur’s Gate 3 team produced a game which is one of the highest rated games of all time, winning three awards at The Game Awards 2023. Yet a significant portion of the wave of layoffs hit the development teams of these extremely successful IP’s.

While I was previously considering making an investment into Hasbro, I am no longer considering them as an option. After looking over their financials and valuation, I presently rate Hasbro as a Hold.

Company Background

Hasbro, Inc. is a provider of toys and games. They operate through three segments: Consumer Products, Wizards of the Coast and Digital Gaming, and Entertainment. The company was founded in 1923 and bought Wizards of the Coast in 1999 for $325M. This expanded their already established offerings from board games and action figures to also include Dungeons & Dragons and Magic: The Gathering. They acquired D&D Beyond in 2022 for $146.3M.

The Consumer Products segment focuses on toys and games. This includes action figures, arts and crafts and creative play products, fashion and other dolls, play sets, preschool toys, plush products, sports action blasters and accessories, vehicles and toy-related specialty products, games, and other consumer products. This segment also handles licensed products, such as apparel, publishing products, home goods and electronics, and toys.

The Wizards of the Coast and Digital Gaming segment focuses on trading card games, role-playing games, and digital games.

The Entertainment segment focuses on film, scripted and unscripted television, family programming, digital content, and live entertainment.

Industry-Wide Trends

The global toys and games market is expected to experience a CAGR of 4.3% through 2030. The global trading card game market is projected to have a CAGR of 7.69% until 2030. The global role playing games market is expected to experience a CAGR of 7.91% through 2027. The global media and entertainment market is projected to have a CAGR of 5.9% until 2031.

The Hypocrisy Of The Layoffs

Two weeks before Christmas, it was announced that Hasbro was laying off 1,100 employees. While poor toy sales were cited as the reason, they chose to expand their layoffs to the development teams for both MtG and D&D. They chose to slash 15% of their workforce, yet as far as I can tell they didn’t cut executive compensation. The 15% of the employees they let go weren’t the ones who chose to sign the calamitous agreement with Disney; management is to blame for that. The people who should have been let go were the ones who made the decision to continue producing a large volume of products for a company which is currently suffering from a moat erosion. Not only does this diminish my confidence in Hasbro’s management, their decision to lay off employees while not also decreasing their own compensation implies they are self serving.

I am a bit confused as to why they thought this would go over well with their customer base. The gaming community is now going to be more closely watching for evidence that the layoffs have affected the quality of their products. It’s almost as if they don’t realize their products aren’t the only viable option. This hubris may erode consumer opinion and destroy the already established moat this company has enjoyed since acquiring their two most profitable IP’s.

Guidance

Their Q3 earnings call transcript from October revealed that they were planning on improving margins by revamping the materials and construction methods for popular games, such as Jenga, and reducing overall inventory levels. They are entering into a collaboration involving the video game series Fallout.

Despite the absolute disaster that partnering with Disney produced for them in 2023, they are planning on collaborating with them on a multiset referenced as Magic and Marvel, as well as releasing products focused on Star Wars and Marvel through Pulse.

During their Q3 earnings call, instead of giving us numerical estimates for revenue, EBITDA, and margins for Q4, they told investors that they were going to drive share momentum by emphasizing cost savings.

Their Q4 earnings call transcript indicated that they are moving forward with an initiative they are referring to as Fewer, Bigger, Better. They are transforming their business model into one which relies on fewer SKU’s. They eliminated roughly half of their SKUs, which comprised only 2% of their revenue. This is reducing the network and creation costs for them and their retailers. They are also shifting to an out-licensing model for some brands.

At the end of the year, they closed a deal with Lionsgate on eOne Film and TV. They expect to be able to use the proceeds from this deal to pay down their debt by approximately $400M. The sale of eOne had them incur a $1B noncash impairment.

In 2024 they expect that Wizards revenue will be down 3% to 5%, Consumer products revenue will be down 7% to 12%, and that Entertainment revenue will be down roughly $15M versus last year.

Due to their many separate cost savings measures, they expect for their annual EBITDA for 2024 to rise by between $215M and $290M from 2023’s numbers. They project for roughly $225M to be available to allocate to growth initiatives and infrastructure.

The company has adopted a strategy which has them cutting their less profitable SKU’s while revamping their manufacturing processes so they can use cheaper materials. This should allow them to downsize into a business model which has higher margins.

Annual Financials

The company has suffered two revenue declines over the last decade, but is still generating more than it was a decade ago. In 2014 they had an annual revenue of $4,277.2M. By 2023 that had grown to $5,003.3M. This represents a total rise of 16.98% at an average annual rate of 1.89%.

Their gross margins have been slowly contracting since their peak of 53.26% in 2016. The cost savings program they have been implementing through revamping how their products are manufactured may lead to an improvement in gross margins. As of the most recent annual report, gross margins were 48.37%, EBITDA margins were 9.48%, operating margins were 5.27%, and net margins were -29.77%.

Their pace of dilution has been low over the last decade. Total common shares outstanding was at 124.5M in 2014; by the end of 2023 that had risen to 138.9M. This represents a 11.57% rise in share count, which comes out to an average annual rate of 1.29%. Over that same time period operating income fell from $641.5M to $263.7M, a -58.89% total decrease at an average rate of -6.54%.

They took on a significant amount of debt in 2019. It rose further in 2020, but long-term debt has been declining since then. As of the 2023 annual report, they only had -$186.3M in net interest expense, total debt was $3,465.8M, and long-term debt was $2,965.8M. As of 2023, their long-term debt to annual operating income ratio was 8.15x. I typically consider anything below 3x to be attractive and anything above 10x to make a company un-investible.

Their annual cash flow fell into a low in 2019 before rising significantly the following year. As of this most recent annual report, cash and equivalents was $545.4M, operating income was $263.7M, EBITDA was $474.5M, net income was -$1,489.3M, unlevered free cash flow was $621.1M, and levered free cash flow was $504.7M.

Their total equity rose significantly in 2019, was fairly stable until 2021, but fell slightly in 2022 before dropping significantly in 2023. Both assets and liabilities have been falling since their peak in 2020. If the value of their assets continue dropping at a rate which is faster than their liabilities, they may end up with negative equity.

For annual returns, I typically consider values above 10% to be attractive. Their returns have not been as attractive in recent years as they were previously. In 2022, I would have called their returns unattractive, now that their fiscal 2023 is complete it is clear that their returns have worsened and both ROIC and ROE are negative. As of the most recent annual report ROIC was -41.25%, ROCE was 4.37%, and ROE was at -137.01%.

Quarterly Financials

Their quarterly financials are showing clear seasonality. They typically experience elevated revenue every Q3 and Q4 and diminished revenue in Q1 and Q2. Unlike Q4 for both 2021 and 2022, their Q4 for 2023 saw a significant drop below their Q3 values. I believe a majority of this can be blamed on a combination of inflation and the dramatic drop in toy sales related to Disney’s poor box office performance.

Eight quarters ago Hasbro had a quarterly revenue of $2,013.4M. Four quarters ago that had declined to $1,678.5M. By this most recent quarter that had declined further to $1,288.9M. This represents a total two-year drop of -35.98% at an average quarterly rate of -4.50%.

Hasbro typically experiences their lowest margins every Q4 and highest margins every Q2. While seasonality usually drives elevated revenue during the holiday shopping season, it has a history of pushing their quarterly margins down. This most recent quarter saw the lowest margins the company has experienced of the 11 quarters shown. As of the most recent quarter gross margins were 35.60%, EBITDA margins were -5.80%, operating margins were -10.28%, and net margins were at -82.33%.

While they appear to have become less profitable over the last two years, this has yet to lead to an increase in dilution. The sum of their last eight quarters of dilution comes to 0.51%; over the last four quarters this has risen/dropped to 0.51%.

As mentioned earlier, the sale of eOne has allowed them to pay off a portion of their debt. The most recent quarter, Hasbro had -$46.3M in net interest expense, total debt was at $3,465.8M, and long-term debt was at $2965.8M.

As of the most recent earnings report, cash and equivalents were $545M, quarterly operating income was -$133M, EBITDA was -$74.8M, net income was -$1,061.1M, unlevered free cash flow was $515M, and levered free cash flow was $486.1M.

Again related to the sale of eOne, their total equity experienced a significant drop this most recent quarter.

While their ROIC and ROE were already showing up as negative on their annual financials, their quarterly financials are showing that their ROCE was also negative this most recent quarter. As of the most recent earnings report ROIC was -25.44%, ROCE was -2.19%, and ROE was -97.62%.

Valuation

As of March 7th 2024, Hasbro had a market capitalization of $7.13B and traded for $51.36 per share. Using their forward P/E of 17.12x, their EPS Long-Term CAGR of 11.61%, and their forward Yield of 5.45%, I calculated a PEGY of 0.9965x and an Inverted PEGY of 1.004x. With PEGY-based valuations, anything above 1.5x is considered overvalued, anything below 1x is considered undervalued, and anything between 1x and 1.5x is considered as trading within the range for its fair value. As the PEGY value is very close to 1, I view the company as presently trading near the bottom end of the calculated range for its intrinsic value.

Risks

As I cited earlier, Hasbro has shed developers from not only its struggling segments, but also from its only profitable one. The integrity and long-term health of their most popular IP’s (D&D and MtG) may now be in danger of losing their customer base to other games. If the gaming community which supports them decides that the quality of their products has diminished, then they are likely to move on to other games. Similar events have already happened to other IP’s. A couple years ago a significant number of Warhammer 40K players shifted to playing Battletech after it became clear that Games Workshop was milking them through blatant cash grabs instead of focusing on maintaining a high quality game that was fun to play.

If Hasbro continues to make high volumes of products for Disney while they suffer from further lackluster box office performance, then Hasbro may end up repeating the mistakes that were made in 2023. This has the potential to cause additional financial damage to Hasbro. I should note that it is possible that Disney manages to pivot back into making movies with broad market appeal, so this outcome is not guaranteed.

Catalysts

The company is taking significant steps toward improving its bottom line. If they can also maintain the quality of their two flagship IP’s, then the company is likely to come out much stronger on the other end. A leaner, more efficient version of Hasbro has the potential to produce better margins and be more attractive to both current investors and potential future investors.

The company currently has a long-term debt to annual operating income ratio of 8.15x. I consider anything above a 3x to be unattractive. If Hasbro were to stop paying its dividend and instead focus on paying down its $2965.8M in long-term debt, after a few years it could find itself in a far more financially healthy situation.

Conclusions

Overall, this appears to be a struggling company attempting to pivot into a more efficient business model. However, the short sightedness of removing game developers from their most profitable segments after one of the most successful years those IP’s have ever experienced, coupled with their current debt situation, prevents me from considering them as investible at this time.

I have been an enjoyer of their games and products for over two decades. As a consumer, I will be watching for a decline in their quality going forward. Going forward, I expect them to survive their current troubles, and may yet one day make an investment here. If their downsizing ends up improving margin by enough that their annual return on capital employed approaches or exceeds 10%, I will reconsider them as a potential investment. I wish them the best of luck, and will continue to keep an eye on their situation as it develops.