The Long and Short

Rising star Mattel offers value to peers

Meredith Contente | May 5, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Mattel (MAT) was recently upgraded to investment grade status by S&P, after first quarter 2023 earnings highlighted strong underlying fundamentals, while outpacing the toy industry on point-of-sale (POS) growth. The upgrade by S&P comes roughly six months behind Moody’s upgrade to Baa3 in November of 2022. The company’s rising star status helps to transform the capital structure, as collateral pledges on its previously secured revolving credit facility and guaranteed unsecured bonds have fallen away with the investment grade ratings. Furthermore, the inclusion of MAT’s corporate bonds back into the investment grade credit index should improve liquidity.

MAT’s curve trades significantly wide to its closest peer Hasbro, Inc. (HAS – Baa2/BBB/BBB-). While HAS maintained its Investment Grade status post the bankruptcy of Toys ‘R’ Us and through the pandemic, HAS’ leverage has been out of its target range since the close of the Entertainment One Ltd in late 2019. Despite having a notch higher rating across all three rating agencies, HAS ended 1Q23 with gross leverage of 3.6x, above the 2.9x posted by MAT and should only see leverage in the low 3.0x area by year-end, relative to the 2.5x gross leverage guided to by MAT management. Furthermore, MAT’s net leverage of 2.3x is a full turn lower than HAS. Given the positive outlook at S&P, MAT could be an upgrade candidate if net leverage is maintained below the 2.5x level, which would be a further catalyst for spread tightening relative to its peer.

Exhibit 1. MAT Curve Relative to HAS

Source: Bloomberg TRACE; SanCap

First Quarter POS Growth Outperforms Industry – Guidance Affirmed

While first quarter gross billings were down year-over year, the decline reflected the negative impacts from tight inventory management among retailers, affecting all toy manufacturers. MAT noted that POS significantly outpaced gross billings by double-digits across all categories and all power brands. POS grew by mid-single-digits relative to the year-ago period, which outperformed the industry, thereby helping MAT to gain market share in the quarter, particularly in North America and Latin America. MAT noted that they expect retailers to continue to manage inventory in 2Q23 with 2H23 shipments reverting to historical trend levels.

The POS performance underscores the fundamentals of the business, as management believes they can continue to outpace the industry and gain further market share as the year progresses. Given the 1Q23 performance, management felt confident in reiterating its guidance. Full year guidance is expected to deliver comparable net sales growth to fiscal 2022 and between $900 million-$950 million of adjusted EBITDA. Additionally, MAT has guided to at least $400 million of free cash flow generation, up from the $256 million posted in 2022.

Exhibit 2. MAT Full Year Guidance

Source: MAT Earnings Presentation

Net Leverage Already Below Threshold for Upgrade

MAT ended 1Q23 with gross leverage of 2.9x and net leverage of 2.3x. That said, net leverage is already below the 2.5x threshold needed for an upgrade according to S&P. Management has guided to gross leverage of 2.5x by year-end, which would put net leverage comfortably below 2.5x. Given management’s guidance for adjusted EBITDA to be in the $900 million – $950 million range, we see at most $75 million of additional debt reduction should adjusted EBITDA come in at the low-end of the range. Should MAT come in at the high end of the EBITDA range, no further debt reduction will be needed to hit its 2.5x gross leverage target.

That said, net leverage could fall below 2.0x by year-end, even if MAT needed to repay the aforementioned debt to hit its gross leverage target and after cash spent on share buybacks. MAT resumed share repurchases in 1Q23 after a nine- year hiatus, having spent $34 million on repurchases in the quarter. Management noted that they plan to continue repurchasing shares throughout the year and have $169 million of authorization left under their current buyback program.

Fitch Holding on to HY Ratings

Fitch equalized MAT’s ratings at BB+ across its capital structure post the collateral fall-aways and left all ratings on positive outlook. Fitch noted that the change in the ratings reflected the transition to an unsecured capital structure as well as the much-improved credit metrics. According to the agency, the positive outlook accounts for the company’s improved competitive position as well as its ability to better navigate macroeconomic volatility due to its stronger balance sheet. Additionally, MAT stands to benefit from incremental revenue from both the Disney Princess and Frozen licenses, which returned to MAT this year. The agency has noted that they would look to upgrade MAT on increased confidence in the sustainability of market share and margin gains, while maintaining gross leverage below 3.5x. With leverage comfortably there, Fitch may need to revisit its rating in the back half of the year should shipments resume to historical trend levels.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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