Hasbro, Inc. (NASDAQ:HAS) earlier this week announced Q3-20 earnings that beat expectations at the top and bottom. The company reported in-line GAAP earnings of $1.61 and adjusted earnings of $1.88 for a 17% surprise over the expected $1.61. Despite this and the revenue beat of $40 million, the stock has lost significant ground in the last two days, initially dipping by about 7% and currently trading at around $85 as of this writing.

Thesis

There’s ample growth opportunity in FY-21 as the entertainment, licensing, and digital segment bounces back, driven by a more normal cadence of releases. However, there is more than one indicator that points to the depressed growth of multiple segments in the short term. For now, the only bright spots appear to be the Gaming and Franchise Brands segments, with Emerging Brands and eOne TV/Film/Entertainment continuing to be a significant drag on revenue growth, but the company continues to “believe that we could grow revenues and adjusted EPS from our pro forma Q4 results of 2019 overall as a company, because well eOne and the live action production that’s returning, we’ve been in production on animated overall training for better deliveries.”

Nevertheless, investors might find it prudent to wait until these and other variables play out, primarily because of the magnitude of uncertainly around the economy over the holiday quarter and its potential impact on the company’s Q4 performance.

Internal and External Indicators

The major hit in Q3-20 came from delivery delays in live-action production due to shutdowns. The tail-end of Q3 saw some locations return to production, but there will be a significant revenue shift to FY-21, as indicated by content spend now being estimated at the lower end of the $450 to $550 million guidance. Per CFO Deb Thomas at the Q3 earnings call:

Due to the timing of this return to production, certain deliveries expected in the fourth quarter 2020 will move to 2021, shifting expected revenue. We currently expect next year to have a more normalized cash spend level as production and deliveries are slated to improve from the lower 2020 levels.

Of the “30 brands and more than 40 projects stood up”, some are slated for Q4 delivery, which should help the company recover considerably in eOne revenues as we move through the next two quarters; however, we should still expect to see a decline over Q4-19 pro forma numbers in that line item. As such, investors should look for sequential revenue growth in the eOne TV/Film/Entertainment segment from Q3-20 through Q1-21, which will indicate a gradual return to normal production levels.

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That said, there could be further production delays in several locations due to the increase in the number of daily positive COVID-19 cases in the United States. Although a nationwide lockdown is still legally questionable, the chance of states implementing specific restrictions looms large as the holiday quarter progresses. With the American public already having protested large-scale stay-at-home orders in the past, state Governors will have to make some tough decisions over the holidays.

What might make the situation worse is the timing. We’re already into the 2020-2021 influenza season and, although the CDC says that “seasonal influenza activity in the United States remains low,” the initial demand for flu shots is primarily driven by the ‘over 65’ demographic, and experts say that “the initial rush could taper off.”

As such, this is still a variable that could directly impact the holiday shopping season for physical retail. Specific to Hasbro, the challenge now is to manage retail inventories versus making adequate inventories available for e-commerce distribution. Since digital is already growing at mid-double-digit rates, there will be additional pressure on the supply chain to balance inventories and address elevated demand on the digital front.

In terms of geographical markets, Latin America will continue to present a challenge, and the 4% increase in Q3 revenues from European markets doesn’t reflect what we could expect in Q4. The obvious reason for that is the second wave of COVID-19 positive cases across Europe, which has forced EU member states to implement restrictions on several fronts. In Q3, Europe was able to partially offset the steep declines in Latin America, which may not be the case in Q4.

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Moreover, the 9% YoY revenue growth in the U.S. and Canada segment posted in the third quarter is by no means an accurate indication of what to expect in Q4. With U.S. Senators having left for the pre-election break, the chances of a pre-election stimulus bill are now zero. This is further exacerbated by the fact that, even if an agreement is reached in November, the checks will only start coming in about two weeks after that, by which time we’ll be entering the final month of the holiday quarter.

The company is confident about showing YoY growth in Q4-20, but there are still several variables that are in play that add to the risk element.

Investor’s Angle

With so many headwinds on the horizon, it will be a massive task for Hasbro to show YoY growth in Q4-20 over pro forma Q4-19, more so when you consider that much of that growth will have to continue to come from toys, games, and digital, with currently-unpredictable contributions from live-action productions slated for this quarter.

When you look at the stock’s valuation multiples, the risk is even greater. Although HAS is now nearly 20% down on a YTD basis, TTM and forward GAAP earnings multiples are still close to 30, which is around 20% higher than the sector median. The market is clearly not impressed with the company’s performance in Q3-20, and with Q4 facing even greater risks on multiple fronts, it might be prudent to wait for a further pullback from the current price.

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To be amply clear, I’m quite bullish on the stock even at the current price. We should expect to see a major bounce-back in FY-21, and the stock should show significant appreciation over the medium term. Getting in at the as-of-writing price of slightly over $85 still represents significant upside potential, as evidenced by median price targets ranging from $89 to $99. However, considering the state of the economy and other macro factors and their potential impact on Q4-20 performance, I would recommend waiting for a better entry point on HAS. We’re yet to see a clear path to the revenue and earnings growth that FY-21 promises.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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