When I recommended Hasbro ( HAS) as one of my Top 10 Turnarounds in December, the company was an operational mess. The stock was thoroughly trashed at the time, down from a 1999 high of $37 to only $10 a share. Since then, Hasbro has appreciated about 60% and, importantly, the stock is poised to go still higher. Hasbro's fall from grace in 2000 was based on a series of problems: Debt had rapidly increased, inventories were out of control, margins were in free fall and the revenue base was overly dependent on Pokemon, which accounted for one-quarter of year 2000 revenue.
Office Depot Arne Alsin and Chris Edmonds
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While that is all bad news, it's also old news. Hasbro has been completely reconfigured. Here are the strengths that the company is building on to regain past glory:
Strong Free-Cash Flow: While Hasbro was clearly mismanaged in recent years ("operationally challenged" is a fair characterization), they are historically a free-cash flow machine. For example, free-cash flow averaged a healthy $1.20 a share each year from 1997 to 1999.
Product Line: The reliance on Pokemon is history -- now, no single product represents more than 7% of overall revenue. Hasbro has many promising new products in the pipeline: POX (a handheld video game), Harry Potter trading cards and Bob the Builder toys, as well as licensed toys from anticipated hit movies like Monsters, Inc. And, of course, Hasbro has an impressive portfolio of brands with lasting value: Milton Bradley, Playskool, Parker Bros., Tonka, G.I. Joe, and Mr. Potato Head, to name a few.
Sept. 11 Impact: I purchase stocks with a minimum one- to three-year holding period in mind, with only nominal concern about the current quarter. Still, I think worries about Hasbro's current quarter are overblown. I rank toys very low on the food chain of potential items that a family trims when economic times get tough. With 80% of Hasbro's product line priced at less than $20, expect solid sales this holiday season.
Operational Improvements: Management has implemented a series of improvements to tidy up the financial house at Hasbro. Short-term debt is down 50% since last year and inventories are lean and mean, down more than 30%. Driving down costs and lifting margins is a prime focus of management.
My biggest concern with Hasbro is the level of long-term debt, which is roughly $1.1 billion against $3.1 billion of sales -- not unreasonable, but far higher than my norm. Almost all of my positions have stellar balance sheets, with zero debt, net of current assets, e.g., Office Depot ( ODP), Liz Claiborne ( LIZ), Manpower ( MAN), Raymond James ( RJF) and Circuit City ( CC). You can make the case that Hasbro's debt is low risk, given the considerable unstated assets that are not recorded on the balance sheet, such as the large amount of retail shelf space that Hasbro commands, the cachet of its various brands (e.g., Monopoly) and the benefits of scale in being the No. 2 toymaker in the world. To be fair, my colleague Gary B. Smith may be right in avoiding Hasbro at the current quote. I bought Hasbro at lower prices and am not chasing the stock now, preferring to wait for pullbacks to add shares. Given how messy operations were in 2000, I think we are only in the third or fourth round in this 12-round prize fight. I'm going to stick around and see how it turns out.
Who won today's Face-Off? Arne Alsin Gary B. Smith