It happens every year. You sit down in late July and try to figure out which of the two toymakers will have a great holiday season. You really only have two choices: Hasbro (HAS) and Mattel (MAT). You can buy one or the other, or you can buy both -- or you can do what I do: Buy Mattel and short Hasbro.
The trade worked out great this year. Since Aug. 1, the S&P 500 is up 7%, Hasbro fell 8.9% and Mattel rose 21.5%. It's really one of the easiest pair trades I can think of. But now what? Keep the trade on or liquidate both positions and enjoy an early retirement south of the border?
First, let's dispel any notion that these are growth stocks -- there're really not. Both companies are low-single-digit growers. For example, in terms of revenue, Mattel has a five-year compounded annualized growth rate (CAGR) of 0.97%, and Hasbro has a 2.23% rate. The primary means of earnings growth has been share buybacks and increasing operating income. On that score, Mattel is the winner. In the past five years, Mattel has been able to increase its operating income by a 3.5% CAGR, while Hasbro has only been able to lift its margin by 1.8%. (Yes, this does include the Great Recession, so maybe it's not entirely fair. Let's just say they're sub-5% growers.)
EPS growth also comes from reducing share count. If Mattel reduces its shares outstanding by 4%, earnings per share magically increase 11% to $2.42 from last year's $2.18. And if the company does it again, fiscal 2013 earnings per share will be over $2.60. Hasbro pulls the same trick. Earnings per share are expected to rise 14% to $3.13 in fiscal 2012 and over $3.35 in fiscal 2013, largely through reduction in shares outstanding.
The reason I like to trade these stocks rather than invest is because there are a lot of moving parts in the toy business. When oil prices go up, plastic resin prices go up. It costs more to transport the toys from China, and then there are currency translation issues that always crop up. The companies always seem locked in a price war, and it's often difficult to increase prices anyway. About 40% of revenues for both companies come from just three retailers, which make them subject to the whims of holiday retail.
Right now, Hasbro seems to have a lot of new product momentum. The Transformers toy brand still sells well and there are two new movies slated for summer 2012 release: G.I. Joe: Retaliation and Battleship. Mattel has good momentum in its core brands like Fisher-Price, Barbie and American Girl.
Both companies recently reported soft quarters, but, to me, those were baked into the stocks long ago. Toy investors are always looking forward. Of the two, Hasbro probably has the most "excitement." Hasbro has been very effective at partnering with movie studios and the television industry; for example, Hasbro has a licensing agreement with Marvel and a joint venture with Discovery Communications. In 2011, Hasbro landed a deal with Sesame Street.
While value investors may be drawn to Hasbro over Mattel, I would just take profits and look at the stocks again in July. Who knows -- maybe you'll be able to do another pair trade and retire early like me.