(MAT) Mattel Analyst Maintains Neutral on Shares

We are maintaining our long-term Neutral recommendation for Mattel Inc. (MAT), the world’s largest manufacturer of toys.

Mattel’s first quarter 2011 earnings were in line with the Zacks Consensus Estimate. The company witnessed strong sales driven by core brands such as Barbie and Hot Wheels. Other brands such as Monster High and Disney Princess also contributed to the company’s robust sales. Management expects Monster High to be key growth driver given the expansion of the brand in 15 new markets this year including France, Australia, Portugal, Turkey, Poland and others.

Additionally, Mattel boasts an industry leading position and a strong balance sheet, and the company continues to experience the benefits of its cost containment initiatives. Management is targeting a payout ratio of 50% to 60% in 2011 and cumulative cost savings of $150 million by the end of 2012. Mattel has also implemented a high single-digit price rise in April 2011 to curtail input cost and remains focused on achieving its long-term annual goal of 50% of gross margin and 15% to 20% of operating margins. Retail inventory also remains strong in anticipation of strong demand and higher input cost.

Moreover, Mattel’s focus on top-line growth, margin expansion, building new franchises, optimizing entertainment partnerships, expanding international footprint and effective cash deployment augur well.

However, we remain cautious on the stock based on the ongoing litigation with MGA entertainment over the rights to the Bratz dolls, as in the recent verdict the federal jury rejected Mattel’s Bratz doll copyright claim and awarded MGA with $88.4 million in damages for misappropriation of trade secrets. Furthermore, spike in royalty costs and other input costs will keep margins under pressure. In addition, competition from private label toys and video game industry and unfavorable fluctuations currency exchange rate continue to remain headwinds.

First Quarter 2011 Results

The company posted adjusted earnings of 5 cents per share, in line with the Zacks Consensus Estimate, but missed the prior-year quarter earnings of 7 cents. During the quarter, net sales were $951.9 million, up 8% year over year and were also above the Zacks Consensus Estimate of $907 million.

Gross margin expanded 60 basis points (bps) year over year to 49.7% due to a 60-bp plunge in cost of sales, whereas operating margin contracted 120 bps to 3.9% due to higher other selling and administrative expense ( up 190 bps).

Zacks Consensus Estimate

In the last 30 days, estimates remained unchanged for the second quarter of 2011, fiscal 2011 and 2012, implying that the analysts do not see any near-term catalysts and is in line with our Neutral recommendation. The Zacks Consensus Estimates for the second quarter, 2011 and 2012 are pegged at 16 cents, $2.06 and $2.29, respectively.

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