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Toy Companies‘ Performance third Quarter 2019

Many toy companies have blamed outside forces for poor performance – in 2018 it was the closing of Toys‘R‘Us and 2019 it was the tariffs. Neither was a factor. In the case of Toys‘R‘Us, the consumer simply migrated to other retailers and continued to buy toys there. In the case of tariffs, these just did not materialize in time to affect sales for the first nine months of 2019.

Lutz Muller is an expert for the international toy industry. From 1984 onwards he was a CEO in the manufacturing sector. His consultancy Klosters Trading was founded in 1987, his customers include toy company executives as well as financial analysts. Furthermore, his contacts include buyers for the 30 largest toy retailers of the 17 largest markets worldwide as well as numerous Chinese toy manufacturers. He also publishes a monthly subscription newsletter.

It is interesting to note that the three companies that did well in the 3rd quarter thought that tariffs were no issue whereas the two that did badly in fact blamed their shortfall on them. The Klosters Retailer Panel has found that worldwide growth in toy sell- through was around 3.5 pecent in the third quarter of 2019. None of the 31 retailers in 18 countries we interviewed reported major disruptions due to tariffs or any other issues and these retailers do in fact import considerable quantities themselves either private label or FOB products.

Table 1

Mattel

Graph 1 shows how the company’s gross sales developed over the past few years [note that the 2019 quarterly numbers are annualized over four quarters]. Mattel has clearly stabilized its business during the first three quarters of this year and the sell-through data obtained from 31 retailers in 18 countries suggests that this continued during October with sales growth of four percent which is pretty much in line with overall market growth.
Looking at the company’s financials for the third quarter again suggests that things are on an even keel. The Receivables ratio to sales improved slightly and so did Payables. In other words, Mattel increased its rate of collections whilst also improving on the time in which they paid their bills. The inventory held by the company at the end of the quarter, too, saw a slight reduction. The only negative is the increase in the SG+A ratio. This is how these ratios compare with last year’s third quarter (graph 2). Mattel continues to have significant problems in two of its businesses – American Girl and Fisher Price. In the case of the former there is no clear path forward. The problem is that Mattel is stuck with an expensive brick-and-mortar commitment and is selling a product that no longer warrants the high price tag it carries. Unless very significant product innovation occurs, American Girl will continue to be a millstone around Mattel’s neck. In the case of Fisher Price, the product range is executing a solid entry into the learning market – which so happens to be the fastest growing toy category. Whilst this entry is not yet substantial enough to compensate for the continuing decline of the franchise overall, the expectation is that it will succeed in doing so within the next twelve to twenty-four months.

Graph 1: Gross sales Mattel worldwide

Graph 2: Mattel third quarter 2019 performance

Graph 3: Gross sales Hasbro worldwide

Graph 4: Hasbro third quarter 2019 performance

Hasbro

Graph 3 above shows the progress the company has made since 2016: Hasbro attributed its revenue decline in 2018 to the closure of Toys‘R‘Us. In fact, according to NPD, the toy industry declined in 2018 for the first time since 2009, decreasing two percent across the G11 markets for the year and six percent in the fourth quarter. This statement does not hold water in the face of retailer sell-through numbers as well as just plain common sense. All major retailers polled by the Klosters Retailer Panel reported robust sales for 2018, resulting in toy market growth worldwide in the order of four percent. Where NPD got things wrong is that they knew Toys‘R‘Us’ market share and they deducted this from the total market. What they did not catch was the fact that Toys‘R‘Us’ sales migrated to retailers not normally measured by NPD – mainly Specialty retailers and Amazon’s third party vendors.
Hasbro did not have this excuse for their flat third quarter 2019 performance and they blamed the tariff issue instead. Their claim was that the retailers, being afraid of being caught with a 15 percent surcharge, decided to switch third quartershipments from FOB China [where the retailer is the importer] to direct imports by Hasbro. This switch resulted in delays in sales by Hasbro in the third quarter. There are two problems with this statement. One is that this switch would have been known at the latest early July. Hasbro’s second quarter earnings call was late July and no mention was made of this change. The second is that a switch from FOB to direct imports is simply a paperwork issue and is completely straightforward. The company is the same, the factory is the same, the products and their packaging are the same, container availability and shipping space would have already been booked, and the final destination – the retailer’s warehouse – would also have been the same.

There is another explanation for Hasbro’s third quater 2019 flat performance. The Klosters Retailer Panel recorded sell-through numbers 9.2 percent lower than reported shipments in the first quarter 2019 and 3.5 percent lower in the second quater 2019. On the other hand, the reported shipments for the third quater were 4.2 percent lower than the sell-through numbers. What this tells us is that the retailers simply cut back on shipments to bring their inventories to an acceptable level. The good news is that Hasbro is entering the fourth quarter with a clean slate as far as retailer inventories are concerned. October sell-through numbers suggest growth in the neighborhood of 8 percent. This is likely to accelerate further given the impact of Frozen 2 and Star Wars: The Rise of Skywalker.
Looking at their reported third quater 2019 balance sheet and P+L numbers, one thing stands out. This is the length of the company’s receivables – 82 days of sales – which suggests that the company was aware of an excess of retailer inventories which required a fair degree of tolerance as far as payment was concerned. This is in itself no problem – Hasbro’s cash at hand is by far the largest of the five companies surveyed. However, this could become a problem if the financing of the eOne acquisition does not roll out as currently planned. Retailers get quickly used to long payment terms and will not take kindly to a cutback if such is at some stage forced on the company in order to generate cash. Other than this, the company appears to be on even keel and its balance sheet well managed (see graph 4).

Graph 5: Gross sales Funko worldwide

Graph 6: Funko third quarter 2019 performance

FUNKO

Funko continues to grow well ahead of the market. Its business is basically concentrated in three different product categories – the major one is in Collectibles and this mainly in figurines; the second is Action Figures; and the third is in Apparel. Whilst sell-through in the third quarter grew by 21 percent shipments were well in excess of this – up 26 percent (see graph 5). The difference is due to a continued roll-out of non-Figurines into new channels and retailers, mainly internationally, on one side and a build-up of retailer inventories in anticipation of a very strong fourth quarter. As for October, we are seeing a slight flattening of sell -through at 18 percent. Fourth quarter sales are likely to be driven by two movie licenses – Frozen 2 and Star Wars: The Rise of Skywalker. Funko‘s sell-through was accelerated in November and December because of these two movies.
Turning to the third quarter Financials, this is what graph 6 looked like at the end of Q3. Looking at this chart, there is one major concern and a very significant question mark. The former relates to the sharp increase in Payables days. One of Funko’s overriding strengths has been the company’s ability to bring product to market in record time. A reason for this has been Funko’s readiness to pay its manufacturers much more quickly compared to industry norms with the result that these manufacturers pretty much dropped everything when they got an order from Funko because they knew that they would be paid speedily. With the hike of Payables days from 18 days to 25 days this incentive will be much less compelling and will hence affect one of Funko’s signal advantages. The other issue is that of their cash position which at the end of the third quarter stood at 13.5 million dollar. Had it not been for the described delay in paying its bills, the company would have had a negative cash position of about 3 million dollar.
How the main parameters developed this year you can see in table 1. Whilst Funko continues to be a good payer, the situation has clearly deteriorated and will need watching in the quarters to come. If this trend continues, one of Funko’s major positive differentiators will no longer be the asset it has been up to now.

Jakks Pacific

Jakks had a good third quarter as far as shipments were concerned – up 18.2 percent. However, sell-through numbers generated by the Klosters Retailer Panel suggest that the company grew only by 3.5 percent. The difference is in the very large shipments Jakks made in September in the context of Frozen 2 – both in Fashion Dolls and Disguise. The impact of Frozen 2 is already noticeable in sell-through terms in October – up by 5.8 percent (see graph 7).
Turning to the third quarter Financials, the only thing that stands out is that Receivables as a ratio of sales days declined whilst Payables lengthened. This should have led to an increase in cash which it did – the cash position at the end of the third quarter 2018 stood at 57.1 million dollar and at the end of the third quarter 2019 at 75.9 million dollar (see graph 8).

Graph 7: Gross sales Jakks Pacific worldwide

Graph 8: Jakks Pacific third quarter 2019 performance

Graph 9: Gross sales Spin Masters worldwide

Graph 10: Spin Master third quarter 2019 performance

Spin Master

Spin Master reported lackluster shipments for the third quarter 2019, down eleven percent compared to the same period last year. They explained this by pointing out that they experienced significant supply chain issues due to complications arising from the threatened tariff imposition and the problems attending the consolidation of several warehouses. As a result, shipments were either not made or delayed into the fourth quarter. The Klosters Retailer Panel on the other hand found that sell-through during the same third quarter grew by six pecent. This number is not too inconsistent with Spin Master’s statement made during the Earnings Call that their POS during the third quarter increased by eight percent.
The company is clearly doing well with two major product entries – Bakugan and Candylocks – and also appears to have turned around their all-important Paw Patrol position. This development has more than compensated for the ongoing decline in Hatchimals, a decline that has been reported by the Klosters Toy Manufacturers Newsletter as far back as August 2018. Spin Master’s sell-through in October accelerated further to a plus 9.5 percent rate (see graph 9).
Turning to the third quarter Financials, we notice a sharp increase in inventory days which is not surprising given the supply chain problems reported by the company. More surprising are the increases in both Receivables and Payables days. The former suggests that Spin Master has adopted a more lenient collection approach towards its retailers which is probably a reasonable sweetener to pacify the retailers for the shipping problems experienced by the company. However, the latter – the Payables issue – does not make too much sense. If you have shipping problems to start, why exacerbate the issue by upsetting your vendors by delaying the payments due to them? The only reasonable explanation would be if this exercise was designed to safeguard the cash position given the increase in Receivables days. This has in fact taken place. Cash available went from 143 million dollar at the end of third quarter 2018 to 151 million dollar at the end of third quarter 2019 (see graph 10).

Lutz Muller

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