Mattel Remains Neutral

We are maintaining our long-term Neutral recommendation on Mattel Inc. (MAT - Analyst Report), the world’s largest manufacturer of toys.

Mattel’s second quarter 2011 earnings were ahead of the Zacks Consensus Estimate. The company witnessed strong sales driven by the success ofthe film Cars 2, and the strong performance of its core brand Barbie and other girl brands resulting from the continued worldwide penetration of Monsters High and Disney Princesses.

Sales from the release of the other movie franchise Green Lantern were also satisfactory and are expected to gain momentum as the animated series premieres in November on Cartoon Network. Despite the drop in Hot Wheels sales during the second quarter, management remains optimistic on Hot Wheels given the improving POS trends, continued strong international performance and new innovative products in the fall season including Wall Tracks, Video Racer and new Rev-Ups line.

Management expects the top line to improve in 2011 and beyond, with the portfolio of Evergreen Entertainment properties, such as World Wrestling Entertainment (WWE - Snapshot Report), Toy Story 3, Thomas and Friends, Cars 2, Disney Princess and Monster High. Moreover, the company’s product line remains strong with the release of films like Brave, Batman - The Dark Knight Rises, and Superman - Man of Steel in 2012.

Additionally, Mattel boasts an industry leading position and a strong balance sheet, and continues to experience the benefits of its cost containment initiatives. Management is targeting a payout ratio of 50% to 60% in 2011 and cumulative cost savings of $150 million by the end of 2012.

Mattel has also implemented a high single-digit price rise in April 2011 to curtail input costs and remains focused on achieving its long-term annual goal of a gross margin of 50% and operating margin of 15%-20%. Moreover, inventories are higher year over year both at the company and at retail for the third quarter of 2011 in anticipation of strong demand.

Furthermore, Mattel’s focus on margin expansion, building new franchises, optimizing entertainment partnerships and expanding international footprint also augur well. Mattel has alliances with entertainment powerhouses like Walt Disney Co. (DIS - Analyst Report)), Pixar, Warner Bros. a subsidiary of Time Warner Inc. (TWX - Analyst Report), DreamWorks, WWE, Nickelodeon, HIT etc.

Disney plans to support both Toy Story 3 and Cars 2 with cartoon shorts; the Toy Story short cartoon "Hawaiian Vacation" is being shown at the beginning of all Cars 2 screenings and all-new cartoon shorts will be aired prior to the upcoming Muppets movie this fall. For Cars, the company plans to air new cartoon shorts throughout 2012 and will feature Planes on Blu-ray and DVD in Spring '13 tied to Cars. Mattel will be producing the toy lines for Planes.

Disney will also release the all-new "Tangled" animated cartoon short in 2012. To cater to the infant and pre-school category, Disney will be focusing on Mickey and will feature "Rock Star Mickey" in the second half of 2011 as well as expand the Minnie line in early 2012.

Mattel also will be working with Dreamworks on 5 films including Kung Fu Panda 2, Puss n Boots, Madagascar 3 and other titles. With Nickelodeon, Mattel continues to produce Dora the Explorer lines for the tenth year; along with feature lines like Fiesta Kitchen and Magical Fairy Dora.

However, we remain cautious on the stock based on the ongoing litigation with MGA entertainment regarding the Bratz dolls rights. In the recent trial, the federal jury rejected Mattel’s Bratz doll copyright claim and awarded MGA with $309.8 million for misappropriation of trade secrets, copyright infringement, breach of contract and other issues, against the previous judgement of $88.4 million in damages.

Moreover, a spike in royalty costs and other input costs will keep margins under pressure. In addition, competition from private label toys and the video game industry and unfavorable fluctuations in currency exchange rate continue to remain headwinds.