Despite its price doubling since early 2015, this industry leader still has room to run. With improving profitability, strong industry growth and an undervalued share price, this stock could outperform moving forward. Hasbro (HAS) is this week’s Long Idea.
Hasbro Consistently Improves Profitability
Hasbro has grown revenue 5% compounded annually over the past decade. Over the same time, after-tax profit (NOPAT) has increased 9% compounded annually. Profit growth has been fueled by HAS’ improving NOPAT margin, which has improved from 8% in 2006 to 12% TTM per Figure 1. Longer-term, Hasbro has grown NOPAT by 7% compounded annually since 1998.
Figure 1: HAS Profitability Improvement Since 2006
In addition to NOPAT growth, Hasbro has generated a cumulative $2.5 billion (19% of market cap) in free cash flow (FCF) over the past five years. Hasbro’s $757 million in FCF over the last 122 months equates to a 5% FCF yield. Hasbro has also exhibited good stewardship of capital and has earned a double digit return on invested capital (ROIC) every year for the past decade. HAS currently earns a 17% ROIC, which is in the top-quintile of our coverage universe.
Executive Compensation Plan Is Directly Aligned With Creating Shareholder
Hasbro’s executive compensation plan includes base salary, annual incentives and long-term stock based compensation. One-third of performance share awards, which make up 50% of long-term incentive compensation, are tied to average return on invested capital over a three-year period. ROIC was added to Hasbro’s executive compensation plan in 2015 based on shareholder feedback.
The new focus on ROIC helps ensure executives continue to be good stewards of capital. Per Figure 2, Hasbro’s ROIC has improved from 4% in 2001 to 17% TTM. In addition, Hasbro has grown economic earnings from -$102 million in 2001 to $438 million TTM.
Figure 2: Hasbro’s Exec Comp Plan Drives Rising ROIC
We know from Figure 3 below, and numerous case studies, that ROIC is directly correlated to changes in shareholder value. HAS’ use of ROIC to measure performance ensures executives’ interests are aligned with shareholders’ interests and earns it a spot on May’s Exec Comp Aligned with ROIC Model Portfolio.
Improving ROIC Correlated with Creating Shareholder Value
Per Figure 3, ROIC explains 86% of the changes in valuation for the 19 Leisure Product peers under coverage. Despite HAS’ 17% ROIC, above the 12% average of the peer group, the firm’s stock trades at a discount to peers as shown by its position below the trend line in Figure 3. If the stock were to trade at parity with its peers, it would be $123/share–9% above the current stock price. Given the firm’s rising ROIC, shareholder-aligned exec comp plan, and consistent profit growth, one would think the stock would garner a premium valuation.
Figure 3: ROIC Explains 86% Of Valuation for Leisure Product Firms
Hasbro’s Profitability Helps Build Market Leading Position
As a leader in the toy and game market, Hasbro’s biggest competition comes from Mattel (MAT), the maker of Barbie and Hot Wheels. Per Figure 4, Hasbro’s NOPAT margin and ROIC rank well above Mattel and near the top of peers such as JAKKS Pacific (JAKK) and leisure product companies Escalade (ESCA) and Callaway Golf (ELY).
Hasbro’s licensing model, which includes deals with Walt Disney Company (DIS) and DreamWorks, and its in-house brands, Monopoly, My Little Pony, Nerf and Play-Doh among others, provide many profitable business lines. High margins have allowed HAS to invest profits into developing new products, such as new NERF toys or even short video series’ that tie into its existing brand names. At the same time, Hasbro is able to withstand pricing pressures from Mattel and other game makers, or look to lower its own prices in an effort to gain market share. Most importantly, high margins allow Hasbro to bid competitively for lucrative licensing deals, such as the current deal with Disney running through 2020.
Figure 4: Hasbro’s Profitability Ranks Highly Among Peers
Bear Concerns Focus on Diminished Toy Sales At Home & Abroad
On a macro level, the U.S. economy is steadily improving. Wages are slowly rising, unemployment remains low, and consumer spending is growing. Each of these macro trends creates a positive business environment for Hasbro.