Published by Bob Ciura on May 9th, 2017
A high dividend yield can be enticing, particularly for investors who desire investment income. With interest rates still low, high dividend yields are especially attractive.
But a high dividend yield can be a sign of danger. In some cases, elevated dividend yields are the result of a falling share price, due to deteriorating company fundamentals.
As a result, investors need to tread carefully with high-yield dividend stocks.
Toymaker Mattel (MAT) has seen its share price drop by one-third over the past five years, due to falling sales across several major products, including its flagship Barbie line.
Due to its plunging stock price, Mattel now sports a nearly 7% dividend yield. It is one of 295 stocks with a 5%+ dividend yield.
Before investors rush to buy the stock, it is imperative to dig deeper into the company’s fundamentals.
This way, investors can ascertain whether the high dividend yield is truly a diamond in the rough, or if it is a trap.
Mattel designs and manufactures toys and games. Its product portfolio includes the following major brands:
- Hot Wheels
- American Girl
Barbie is Mattel’s most important individual product line. Barbie itself accounted for 18% of Mattel’s net sales in 2016.
The company is also hurting from the strong U.S. dollar, which makes exports less competitive. Mattel sells its products in more than 150 countries around the world. Approximately 40% of Mattel’s 2016 net sales were derived outside the U.S.
Barbie returned to 7% revenue growth last year, which gave Mattel investors hope that the turnaround was gaining momentum. Unfortunately, declines in other areas offset this.
For example, the loss of Disney (DIS) Princess dolls to fierce competitor Hasbro (HAS) in late 2015 caused Mattel nearly $500 million in lost product sales.
In all, Mattel’s earnings-per-share declined 15% in 2016, to $0.92 per share.
Unfortunately, conditions have continued to deteriorate in 2017. This has cast doubt on whether Mattel’s turnaround will be successful.
Mattel’s first-quarter worldwide sales declined 15%.
The core girls and boys operating segment posted a 16% decline in revenue, due to an inventory overhang associated with a poor holiday shopping season.
Source: Q1 Presentation, page 5
Mattel lost $127 million, or $0.33 per share, in the first quarter.
That said, management believes a turnaround is right around the corner. Mattel is pinning its hopes on a continued recovery in Barbie sales, as well as growth from new franchises, one of which is the upcoming Cars 3 line.
The movie is set for U.S. release on June 16th.
In addition, in February 2017, Mattel signed a partnership deal with e-commerce giant Alibaba (BABA).
Under the agreement, Mattel will be able to sell toys in China through Alibaba’s enormous online marketplace.
Not only that, but Mattel will also be able to use data derived from customers, to develop new toys to more effectively market to Chinese consumers.
Therefore, China could be a huge catalyst for Mattel.
Overall, Mattel believes its turnaround initiatives will result in mid-to-high single digit revenue growth in 2017.
To boost earnings growth, Mattel is also targeting gross margin expansion, by cutting costs primarily in its supply chain and advertising spending.
Mattel is accelerating cost savings through automation, and increasing productivity by expanding efficiency in design, tooling, and logistics.
Source: 2017 New York Toy Fair Presentation, page 3
In all, Mattel expects to generate $120 million in annual savings from these initiatives, in 2017 and 2018.
Separately, Mattel also plans to lower advertising spending to 11%-13% of net sales, which is below its historical rate of advertising expense.
As a result, Mattel expects adjusted operating margin will expand by 100-200 basis points in 2017. Even so, it is doubtful that Mattel will generate enough earnings growth to cover its dividend in 2017.
A company can only maintain its dividend if it is generating enough earnings to support its payout. Mattel has a current annualized dividend payout of $1.52 per share.
In 2016, Mattel earned $0.92 per share. This means its earnings were insufficient to cover the dividend. The same pattern held true, when viewing Mattel’s dividend sustainability through the lens of cash flow.
Last year, Mattel generated operating cash flow of $595 million. The company spent $140 million to purchase raw materials such as tools, dyes, and molds, and another $122 million on property, plant, and equipment.
After excluding these capital expenditures, free cash flow was $332 million. Its dividend cost the company $518 million in 2016.
Mattel is burning through cash in order to maintain its dividend. Mattel’s end-of-year cash balance fell from $972 million in 2014, to $870 million in 2016.
Mattel has also taken on debt in recent years, to help raise cash. Long-term debt on the balance sheet rose to $2.13 billion at the end of 2016, up from $1.78 billion at the end of 2015.
Mattel can continue paying the dividend out of existing cash on hand and debt issuances for a time, but not forever. It cannot continue to burden its balance sheet with debt, just to keep paying the dividend.
If cash flows do not increase enough to cover the dividend, at some point management will cut the dividend.
As a result, based on the company’s fundamentals, there is a fairly high possibility the dividend will be reduced.
Just when it seemed Mattel was gaining traction in Barbie sales, it got hit with setbacks across other product lines.
The company has reiterated its intention to maintain the dividend at least for 2017. But over the long term, whether Mattel can sustain its dividend will ultimately depend on the success of the company’s turnaround.
It is impossible to determine with absolute certainty whether the company’s dividend will survive intact.
However, the prospects don’t look good. Mattel didn’t cover its dividend with enough earnings last year, and likely will not in 2017. This is unsustainable over the long term.
Investors should price in at least a 50% probability that the dividend will be cut at some point.
As a result, Mattel stock is only appropriate for investors willing to take the risk of a significant dividend cut.
- While Mattel is in decline, one of its biggest competitors—Hasbro—is thriving. To see what Hasbro is doing right, click here.