Play Carefully With Toy Stocks

Most parents are barely starting to think of back-to-school shopping, but toy makers are thinking of the holidays already, and it's looking like a blue Christmas, if things don't pick up soon. Retailers have begun turning negative on the second half of the year, as seen in the June retail sales reports, and for a sector that sells the bulk of the year's product during the fourth quarter, that is troubling.

According to the latest Commerce Department sales tallies, sales at sports and hobby stores are up 7.3% in the first half, but have slowed down lately; June sales were 1.6% below May's. If sales growth is losing momentum, that could be bad news for toy retailers, who placed orders for holiday stock in more optimistic times earlier this year, and a yellow light for investors in toy maker stocks.

Sterne Agee recently issued two reports taking a cautious view on toy makers; analyst Margaret Whitfield noted recent sales data from market research firm NPD shows sales are down in mid-single-digit percentages through May in several key toy segments. Dolls and toy cars -- two categories where Mattel (NAS: MAT) rules -- were only flat, while action figures were down 9.3% and games were down in the mid-teens, bad news for Hasbro (NAS: HAS) , home of G.I. Joe and Monopoly.

Hasbro reports results next week and the consensus is that both revenue and earnings will be down sharply. It's been betting much on the success of movie tie-ins lately, and while Avengers is still killing at the box office, Battleship sunk.

The macro trends led Sterne Agee to take a more defensive stand on toy makers this week, lowering its target price for Hasbro from $40 to $38 per share because of the macro environment and a slowdown in sales of games and action figures that make up the backbone of its product line. Also, Hasbro could be more sensitive to economic swings because it's selling more of its products at higher prices, according to Sterne Agee.

The conventional wisdom is that parents will still buy toys in tough times, but will be more selective, choosing the one item the kids want most. That favors the sector leader -- Mattel. As we have mentioned here before, it has the edge on brands that kids want, like Barbie and Hot Wheels. And this environment is really bad news for a second-tier player like JAKKS Pacific (NAS: JAKK) , which managed to beat estimates, but saw margin contractions across the board.

After Mattel posted strong results this week, Whitfield raised her EPS estimate to $2.44 for FY12 and her price target to $39 per share. Mattel is gaining share despite the weak environment and has the brand power, which can be the winning factor when parents are short on cash and have to pick and choose from Santa's list. Even Zacks, which has a long-term neutral rating on the stock due to cost and competitive pressures, balances that assessment by noting Mattel's leader position and its focus on top-line and margin growth.

Mattel gets a four-star CAPS rating for its leadership position, with some Fools rightly pointing out that the Chinese manufacturing facilities will generate some cost pressures in the future. But with a P/E around 15 and paying a dividend north of 3%, it's a strong player in a difficult market. Hasbro has a lower P/E and pays a higher dividend, but its movie-driven lines have a built-in volatility Mattel doesn't have.

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Mercedes Cardona does not own shares in any of the companies mentioned in this article. Follow her onTwitterand on herwebsite. The Motley Fool owns shares of Hasbro.Motley Fool newsletter serviceshave recommended buying shares of Hasbro and Mattel.Motley Fool newsletter serviceshave also recommended creating a bear put spread position in Mattel. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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