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For Hasbro (NASDAQ: HAS ) stock, there's one key question at the moment. The answer should come reasonably soon - and it will have a big impact on HAS stock.
The question: Is the Toys "R" Us bankruptcy truly the only issue for Hasbro at the moment? That bankruptcy was a major driver of what looked like ugly first-quarter results . Hasbro's numbers missed Street estimates badly: Revenue fell 16% year-over-year, with earnings-per-share dropping to $0.10, on an adjusted basis, against $0.54 the year before.
For the most part, the market seems to have shrugged off the miss. After touching a 16-month low, HAS stock has rebounded. The stock now has regained its levels from before the Toys "R" Us liquidation was announced.
But that seems like it might be too optimistic. Recent results suggest there's more at play (no pun intended) than just weakness at one retailer. In the meantime, Hasbro faces what looks like a very important Q2 report later this month. And if the company disappoints again, it's likely the market won't be nearly as forgiving this time around.
Toys 'R' Us and Q1
Certainly, the Toys "R" Us bankruptcy posed a significant headwind to Hasbro's Q1 results. Total incremental costs - mostly bad debt expense - totaled over $61 million and hurt generally accepted accounting principles earnings per share by $0.49. And liquidation pricing at Toys "R" Us stores contributed to the sharp revenue decline as well.
And as management pointed out on the Q1 conference call, the impact was magnified because first-quarter sales generally are low. (The last two years, the first quarter accounted for just 16% of total revenue.) The impact of the bankruptcy will continue over the year - but should fade, particularly in the second half. While 2018 is going to be a difficult year, business should get back to normal in 2019.
All that said, it's worth noting that Toys "R" Us wasn't the only problem in the quarter. Revenue in Europe dropped 28% year-over-year - despite some help from a weaker dollar. Toys "R" Us locations in the United Kingdom were a contributor - but the biggest driver was a surplus of inventory in the retail channel.
That's not an immaterial problem. Europe accounted for a quarter of sales in 2017. And so even if the U.S. business improves by the holiday season, there could be a lingering headwind to overall sales and profits if that region doesn't improve. Add to that relatively modest growth in the core U.S. market, and there appears to be concerns that go beyond one single customer.
Overall Growth Concerns
The other issue here is that HAS stock doesn't look notably cheap. HAS trades at about 24x the midpoint of 2018 free cash flow guidance. Even assuming a better 2019 - and help from easy comparisons - Hasbro stock still is pricing in rather decent growth. Consensus EPS multiples for next year suggest a forward price-to-earnings multiple of about 18x.
That's not expensive, to be sure. But it's not like Hasbro is in a high-growth industry. Rival Mattel (NASDAQ: MAT ) is struggling badly. Overall industry growth appears to be about 1 percent a year , per estimates.
The loss of Toys "R" Us creates a significant loss from a retail perspective. To offset that loss, Hasbro no doubt will look toward Amazon.com (NASDAQ: AMZN ) and other e-commerce channels. Amazon already is looking to capitalize on the bankruptcy by expanding its toy marketing efforts .
In brick and mortar, Walmart (NYSE: WMT ) and Target (NYSE: TGT ), which accounted for 19% and 9% of 2017 revenue, respectively, will take on greater importance. But both companies are aggressively managing their own inventory at the moment - and Walmart, in particular, is known for its pricing pressure on suppliers.
Can Hasbro grind out growth once the Toys "R" Us headwind moderates? Probably. But HAS stock already is pricing in a decent amount of growth as it is. And if there's a long-term impact from losing a major customer (9% of revenue), and if Europe doesn't get fixed, the company's overall growth profile looks much weaker.
HAS Stock Looks Potentially Dangerous Here
The V-shaped recovery in HAS stock sets up an interesting - and likely important - Q2. Admittedly, expectations are low. The Street is looking for a 13% decline in sales, and adjusted EPS of $0.33 against $0.53 the year before.
But if Hasbro disappoints again, the narrative here could change. Instead of Hasbro being an industry leader that has managed an unexpected event, suddenly HAS looks potentially susceptible to the same headwinds as rival Mattel. (To be fair, Hasbro's balance sheet is much, much stronger.) And if commentary suggests that the Toys "R" Us bankruptcy will have a longer effect than thought, or that Europe's demand issues are becoming more pronounced, the recent gains could reverse quickly.
For now, the market is willing to be patient for Hasbro - but that patience could wear out quickly if the company doesn't deliver on July 23.
As of this writing, Vince Martin has no positions in any securities mentioned.
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