Hasbro: On Top of Its Game

The toymaker is posting strong sales and profit growth, and has avoided the product-recall woes plaguing rivals

The holiday shopping season is a source of elevated anxiety for all retailers trying to attract increasingly cash-strapped customers, and Hasbro Inc. (HAS) is no exception.

But Hasbro is luckier than most. DVD releases of popular kids' films such as The Transformers and Spiderman 3, which comes out next week, promise to bolster interest in related merchandise, making for a very merry sales outlook. What's more, sales are expected to continue into 2008 thanks to a follow-up animated television series based on the Transformers, Hasbro CEO Alfred J. Verrecchia said on Oct. 22.

And while competitors such as Mattel Inc. (MAT) took a beating in the third quarter due to lost sales and costs associated with multiple product-line recalls, Hasbro has so far steered clear of these problems.

The Pawtucket, R.I.-based toy manufacturer reported a nearly 64% jump in profit to $161.6 million, or 95 cents a share, from $99.6 million, or 58 cents a share, a year ago. Excluding a favorable tax adjustment of $29.6 million, or 17 cents a share, the company would have earned 78 cents a share in the latest quarter. Analysts had estimated a profit of 71 cents a share on $1.14 billion in revenue.

Hasbro's shares moved 0.4% lower Oct. 23 to close at $28.29.

So far, Hasbro says it hasn't seen any measurable drop-off in business as a result of the lead-paint related recalls. Larger economic factors, like the effects of high oil prices, are more likely to take a substantial bite out of retail sales than worries spurred by the recalls, Verrecchia said on a conference call to discuss the latest results.

Instead of being an industry-wide issue, the recalls ultimately come down to how stringent each company's testing and inspection processes are, he said.

Since the recalls, Hasbro has stepped up the frequency of its own testing, but that hasn't materially raised its costs or caused delays in getting toys to market, he said. He also stressed that the recalls had affected a very small portion of the three billion toys that are sold in the U.S.

Concerns about recalls of magnet products produced before 2007 have apparently led consumers to avoid Polly Pocket toys, but "Hasbro may capture some of the lost sales with its girl's lines, which include Littlest Pet Shop and My Little Pony," Margaret Whitfield, an equities analyst at Sterne Agee & Leach in Birmingham, Ala., said in a research report on Oct. 17.

Hasbro hasn't hiked its marketing and advertising budget to counter any potential negative impact from the recalls. It does plan to spend more in the fourth quarter than it did a year ago, but that's been the plan all year, Verrecchia said.

If Hasbro does have any problems with any of its products, the company would "address it quickly, openly and decisively," he said.

Net revenue for the North American business rose 10% to $822.7 million, led by shipments of the Transformers and Marvel product lines, and growth in other Hasbro brands such as Furreal Friends, My Little Pony, Monopoly and Scrabble. Operating profit for the segment reported climbed 20% to $134.0 million from $111.6 million a year ago.

He said he was slightly surprised by how broad-based the sales growth was in the third quarter, including a 14% increase in its board games, which include Monopoly and Scrabble.

The company's licensing agreement with Marvel Entertainment (MVL) has resulted in sales that have exceeded expectations and could account for as much as 8% to 10% of worldwide revenue for the full year, he said.

"We see Hasbro as better positioned than Mattel with its focus upon older age groups in boys along with a large board game business," the Sterne Agee note said. "

Further, some consumers may switch allegiance in preschool from Mattel's Fisher Price to Hasbro's Playskool line." (Sterne, Agee & Leach, which has a buy rating on the stock, makes a market in Hasbro shares and has managed or co-managed a public offering or provided other investment banking services for Hasbro within the past 12 months.)

In the international business, Transformers and Marvel products were also key drivers of a 33% surge in net revenue to $374.0 million from $280.4 million in the prior-year period. Nearly one-quarter of that increase came from a positive foreign exchange impact of about $21.7 million, while higher sales in brands such as Littlest Pet Shop and Playskool also contributed. Operating profit in the international segment jumped 33.3% to $57.6 million.

Retailers like Wal-Mart (WMT) and Target (TGT) in general aren't allocating more shelf space to toys, but they have been giving Hasbro more shelf space in their stores, Verrecchia said.

That may be a result of the success its Transformers and Spiderman 3 product lines have had this year. Verrecchia said he's excited by the prospects for sales of toys based on Marvel characters Iron Man and The Incredible Hulk, both of which are being featured in 2008 movie releases, although they won't be as popular as the Transformers or Spiderman.

"Our retailers are looking at these differently than they might have a year ago," he said.

In the girls market, Hasbro's small dolls are selling well, as the softness in that market has been limited primarily to products in the large fashion doll category, Verrecchia said.

The success of video games hasn't done any meaningful damage to the company's toys or games sales, Verrecchia said. But that may be one reason Hasbro entered into a strategic licensing agreement in August with Redwood, Cal.-based Electronic Arts Inc. (ERTS), which will catapult it into the electronic gaming market.

The partnership gives Electronic Arts, a leading interactive entertainment software developer, exclusive worldwide rights to create digital games based on a wide range of Hasbro's intellectual properties, such as Monopoly, Scrabble, Yahtzee, Nerf and Tonka.

Among other things, the relationship will help Hasbro develop a platform for social networking, similar to Barbiegirls.com.

"Their knowledge of the space, coupled with our knowledge of kids, is going to be very beneficial to us," Verrecchia said. While some aspects of the partnership are expected to yield a direct economic benefit, Hasbro also says it will help the company better understand what older kids who are actively engaged in social networking are interested in, he added.

During the third quarter, Hasbro spent $362.1 million to repurchase a total of 12.9 million shares of common stock, and says it has bought back roughly 40 million shares in total over the past couple years. It still has authorization to buy back an additional $240.6 million in stock, but will probably be less aggressive about buybacks in the future due to a decline in cash flow generation, CFO David Hargreaves said on the conference call.

The stock is currently trading at 15.1 times the consensus 2008 earnings estimate, or at roughly a 2% discount to the S&P 500, vs. its five-year average of a 3% discount, JPMorgan Chase & Co. (JPM) said in a research note on Oct. 22. (An affiliate of JPMorgan Securities received compensation for non-investment banking services within the past 12 months. JPMorgan has a neutral rating on the stock.)

"The company will continue to benefit if it is able to grow its core brand revenue as well as continue to execute on its cost cutting program," the note said.

But the company has a slightly weak track record for growing profits and faces fairly difficult comparisons this year, which could hamper growth in 2008, the note added.

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