Toys 'n' gaming giant Hasbro (HAS 0.64%) reported its first-quarter 2022 financial results Tuesday morning -- and while investors seem pleased with the results (shares were up 4% as of 10:30 a.m. ET), the news was actually not great.
Revenue edged out expectations at Hasbro in the quarter, and management raised its guidance for the rest of this year -- two reasons why the stock is up in early trading Tuesday. At the same time, however, Hasbro missed analyst targets for earnings by a sizable margin -- and the company's actual cash profits for the quarter fell right off a cliff.
This is a big red flag for Hasbro investors.
Image source: Author photo.
Hasbro by the numbers
Hasbro's Q1 sales grew 4% overall, with growth ranging from as low as 3% in the consumer products segment, to 4% in entertainment, to a much more impressive 9% at Wizards of the Coast and digital gaming. That's the business that makes Magic: the Gathering, and Dungeons & Dragons -- the business that activist investors keep telling Hasbro to sell!
But the good news pretty much ended with revenue. Operating profit margins plunged nearly 300 basis points to just 10.3% for the quarter. Net income was nearly cut in half, to just $0.44 per share -- and less than analysts had forecast. Bad as that news was, however, the news on Hasbro's cash flow statement was even worse:
Hasbro generated positive cash from operations of only $134.7 million in Q1, down more than 64% from the $377.6 million generated in the year-ago quarter. Subtract capital investments (which were up, not down by the way), and Hasbro's free cash flow for the quarter came to just $105.5 million -- more than a 70% decline year over year.
Hasbro's guidance
Despite this steep fall in cash profits, Hasbro CEO Chris Cocks insisted that his company "executed well" in the first quarter by "growing revenue across segments." While profits and free cash flow were both down significantly in Q1, the CEO said the company's growing sales gave him enough confidence to raise profits guidance for the rest of this year.
Even if revenues continue to grow only in the "low-single digits," explained Cocks, an anticipated surge in "adjusted operating profit margin" (to 16%) could permit Hasbro to grow its profits faster than sales -- in the "mid-single digits." And assuming this holds true for net income as well, it would imply per-share earnings of perhaps $3.25 for all of fiscal 2022.
(That's the $3.10 per share Hasbro earned last year, times 5% growth this year).
Valuing Hasbro
So assuming this is how things play out in 2022, what would it mean for Hasbro's valuation?
Well, first and foremost, it's necessary to point out that Hasbro must earn a lot more than $3.25 per share this year if it wants to keep analysts happy; they're predicting net income of $4.79 per share for the year, and Hasbro doesn't appear to be promising that.
On the other hand, Hasbro's guidance for free cash flow this year is a lot more optimistic -- and much closer to Wall Street's expectations. According to management, Hasbro is looking to generate "operating cash flow in the range of $700 to $800 million" over the course of fiscal 2022. So there's at least a chance the company will achieve the Street's forecast of $800 million in operating cash flow. And assuming capital investments continue running at about the Q1 rate (a bit less than $30 million per quarter), this implies $580 million to $680 million -- $630 million at the midpoint -- for full-year free cash flow (FCF).
At Hasbro's current market capitalization of $11.8 billion, that all values its stock at about 18.7 times current-year FCF. Even factoring net debt into the picture only raises the valuation to 23.5 times FCF. Given that analysts are forecasting Hasbro to roughly double its profits over the next three years, I'd say that's a fair price to pay for the company, with one caveat:
Hasbro absolutely must deliver on its promise to generate significantly more free cash flow over the rest of this year than it did in the year's first quarter. If you only keep track of one thing at Hasbro this year, make it free cash flow. That's the number you want to watch if you own Hasbro stock.
