A Toy Play Now Could Put You Ahead of the Game

By JAMES F. PELTZ

Nov. 11, 1997 12 AM PT

With the holidays fast approaching, should investors put any toy stocks on their wish lists?

Industry watchers think so, even though most of the stocks have struggled all year just to keep pace with the broader market (especially after Wall Street’s steep plunge Oct. 27). This despite the fact that toy manufacturers are enjoying one of their best years in recent memory.

A number of popular toys are keeping the companies flush, including movie-related action figures, computerized “virtual pets” and conventional stuffed toys such as Tickle Me Elmo. Video games also are selling briskly.

So why the lackluster investor interest in some toy stocks?

“There’s no question the toy business is basically mature,” said analyst John Taylor of Arcadia Investment Corp. in Portland, Ore.

Translation: Overall growth in the industry is minimal, and even if a company finds a hot-selling item that helps it temporarily grab market share from others, investors question how long the toy’s appeal will last.

The dollar’s strength versus foreign currencies this year has also kept a lid on some of the stocks by crimping international earnings. Toy makers with overseas distribution, for instance, are seeing their foreign sales converted back into fewer U.S. dollars.

Nonetheless, industry titan Mattel Inc. (ticker symbol: MAT) is a favorite of Jefferies & Co. toy analyst Gary Jacobson, who recently reiterated his “buy” rating on the stock after Mattel posted a 21% jump in third-quarter profit.

The El Segundo-based company is hitting on all cylinders, with its core brands--Barbie, Hot Wheels, Matchbox and Walt Disney-licensed toys--all selling strongly. (U.S. sales of Barbie merchandise are up 24% through the first nine months of 1997.)

Mattel has also gotten a lift from its purchase of Tyco Toys earlier this year, because Tyco makes the popular Tickle Me Elmo toy from the “Sesame Street” series.

But core brands now account for 93% of Mattel’s sales, up from 87% last year, and that “provides stability” in the company’s results, said analyst Ajay Mehra of Morgan Stanley, Dean Witter, Discover & Co.

Mattel, at $38.63 a share as of Monday, has performed the best of any toy stock this year and is handily beating the return of the Standard & Poor’s 500 index. Yet some analysts argue that Mattel still isn’t vastly overpriced. The stock currently sells for 23 times analysts’ consensus estimate of 1997 earnings per share, which is about the same multiple accorded the S&P; 500.

Even the economic turmoil in Hong Kong and elsewhere in Asia isn’t expected to hurt Mattel or its archrival, Hasbro Inc. (HAS), and in fact could help them, said Bear Stearns & Co. analyst John Balaskas.

Neither company sells many toys in Asia, but they “make a significant amount of their products in the region,” Balaskas noted. Hence, if devaluation of the Hong Kong and/or Chinese currencies should occur, it could cut the toy makers’ costs of operating their plants in China and elsewhere in the region, he said.

“Given these relationships, a devaluation scenario could potentially boost 1998 EPS [earnings per share] growth rates by a couple of percentage points,” he said.

Hasbro’s stock has languished this year even though its earnings for the first nine months of 1997 rose 15% from the comparable 1996 period. The stock is up 15% year-to-date, to $29.88 on the American Stock Exchange.

Yet analysts remain mostly bullish on Hasbro, which not only makes toys licensed from such hit movies as “Star Wars” and “Jurassic Park,” but also produces Milton Bradley and Parker Bros. games, Tonka toys and CD-ROM software for home computers.

Pawtucket, R.I.-based Hasbro’s outlook is strong, the company has very little debt, and the stock is priced at just 17 times expected 1997 earnings. Hasbro also enjoyed a big victory recently when the company won the right to make certain toys licensed from three new “Star Wars” movies. However, the payoff for Hasbro won’t be immediate: The first of the new movies is scheduled to hit screens in mid-1999.

The license is important nonetheless. Analysts say “Star Wars” action figures and other items are among the most popular and lucrative toys for boys, and the earlier uncertainty surrounding which company would win the new license had helped keep toy makers’ stocks in check.

As it turned out, “Star Wars” producer Lucasfilm Ltd. divided its award and provided a second license on the upcoming film trilogy to Galoob Toys Inc. (GAL) of South San Francisco, for the manufacture of other products that include small-scale figures and play sets.

“Star Wars” is so central to Galoob’s long-term outlook that, after winning the new contract, Galoob announced plans to revamp its product line to focus on “Star Wars” figures and discontinue other male action toys.

Indeed, sales of some other Galoob items--such as those tied to the movie “Men in Black”--had disappointed this year, leaving investors cold toward the stock, which is down 11% year-to-date.

But Galoob’s announcement prompted analyst Jacobson to remove his “buy” rating on the stock. “We are still very bullish on Galoob’s prospects with ‘Star Wars’ in 1999,” he said, but “we do not believe that investors will have the patience to sit through six quarters of lackluster results.”

Near-term earnings growth hasn’t been a problem for shareholders of video game maker Electronic Arts (ERTS). Video games are red-hot, in good part because a new generation of game players is on the market.

Electronic Arts is on the “buy” list of analyst Andrea Williams of Volpe, Brown, Whelan in San Francisco. Two weeks ago, she considered the stock “fairly valued” because it had risen 30% for the year. But the stock has faltered since the market’s Oct. 27 break and is now up only 11% for the year, at $33.13 a share.

Williams expects the San Mateo, Calif.-based company to continue enjoying robust sales of games for game players made by Sega, Sony and Nintendo. Electronic Arts also has focused heavily on Sony’s new PlayStation--a good move because that player has been among the best-selling of the new generation of players, Williams said.

Indeed, Electronic Arts recently said profit for its fiscal second quarter ended Sept. 30 doubled from a year earlier, to $7.1 million, excluding one-time charges related to an acquisition. Sales surged 38% to $190 million. What’s more, “this is shaping up to be a very strong Christmas” selling season for video games, Williams said.

Meanwhile, Midway Games Inc. (MWY), whose popular game titles include “Mortal Kombat” and “Cruis’n USA,” went public a year ago at $20 a share but is barely higher than that today. The Chicago-based company said profit for its fiscal first quarter ended Sept. 30 climbed 19% from a year earlier, about in line with Wall Street forecasts.

Analysts such as Sean McGowan of Gerard Klauer Mattison have “buy” ratings on Midway, but not simply because they expect strong video game demand in the holiday season. Midway derives about 45% of its sales from producing coin-operated video games for arcades and other sites, so its performance isn’t wholly dependent on the home market.

And what of the toy makers’ best-known outlet, Toys R Us Inc. (TOY)? The big retailer’s stock is struggling relative to the market and is up 13% year-to-date--even though the 1,385-store chain can expect “a pretty strong Christmas” this year owing to sales of such items as video games and movie-related action figures, said Arcadia analyst Taylor.

Toys R Us stock is languishing partly because investors fret that “this incredible surge in demand for video games may or may not be repeated next year,” Taylor said.

Another problem: The company is just now upgrading many of its older stores, whose messy and cluttered appearance had turned off many shoppers, Taylor said.

And the chain is facing increased competition--especially on price--from such discount chains as Wal-Mart, Target and Kmart, which often price toys very low to lure shoppers who they hope will buy other kinds of merchandise.

Times staff writer James F. Peltz can be reached at james.peltz@latimes.com

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Toy Stories

Stocks of Toys and video game makers and of retailer Toys R Us have turned in a mixed performance this year, despite predictions of a strong holiday selling season. Among the majorplayers:

Stock:

Electronic Arts

Ticker symbol ERTS

Mon. close $33.13

YTD chg. +11%

1997 P/E* 28

Galoob Toys

Ticker symbol GAL

Mon. close $12.65

YTD chg. -11%

1997 P/E* 26

Hasbro