We are maintaining our long-term Neutral recommendation on the world’s largest manufacturer of toys, Mattel Inc. ( MAT - Analyst Report ) , based on solid fourth-quarter 2011 results, strong balance sheet, margin expansion, building new franchises, optimizing entertainment partnerships, expanding international footprint and effective cash deployment. However, increased competition, higher input costs and currency fluctuations remain major headwinds for the company.

Mattel’s fourth quarter 2011 earnings were ahead of the Zacks Consensus Estimate. The company witnessed strong sales, driven by strong sales of its core brands including Barbie, Hot Wheels and Other Girl Brands, benefiting from the strength in Monster High and Disney Princess doll line. Net sales were $2,153.8 million, up 1% year over year but below the Zacks Consensus Estimate of $2,221.0 million.

Gross profit rose 6% from the prior-year quarter to $1,160.4 million and gross margin enhanced 230 basis points (bps) year over year to 53.9%, due to lower cost of sales. Operating income expanded 16% to $497.5 million and operating margin enhanced 290 bps to 23.1%, on the back of lower other selling and administrative expenses (down 110 bps). During the quarter, Mattel hiked its quarterly dividend by 35% to 31 cents per share.

Management expects the top line to improve in 2012 and beyond, riding on the portfolio of core Evergreen properties such as Barbie and Hot Wheels, new brand franchise, Monster High as well as the newly acquired HIT Entertainment in February this year. 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.

Moreover, the Monster High franchise continues to witness huge success, enriched by the content of its website, Nickelodeon, and Facebook, as well as through video games and mobile apps. Sales of the brand were strong in both the U.S. and international markets. The brand has been launched across more than 35 countries with Monster High books available in 18 different languages and in more than 20 countries and this will further help to build brand awareness. Furthermore, in 2012, management will continue to capitalize on Fisher-Price’s global opportunity.

Additionally, Mattel boasts an industry leading position 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 also implemented a mid-single-digit price rise in January 2012 to curtail input costs and remains focused on achieving its long-term annual goal of gross margin of 50% and operating margin of 15%-20%.

However, we remain cautious on the stock based on the ongoing litigation with MGA entertainment regarding the Bratz dolls rights. Moreover, spike in commodity expense, transportation cost as well as rise in wages in manufacturing hubs like China are concerning.In addition, competition from private label toys and the video game industry and unfavorable fluctuations in currency exchange rate continue to remain headwinds.