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Tariffs Drive Retail Disruption at Narrow-Moat Hasbro

Despite finally surpassing liquidation pressures from Toys 'R' Us, narrow-moat Hasbro HAS struggled to generate positive top-line growth, with sales rising less than 1% in its third quarter, as both franchise brands and gaming (64% of sales combined) experienced sales declines of 8% and 17%, respectively. Meanwhile, higher royalty expense partner brand sales (27% of revenue) rose 40%, offering a negative mix shift of demand that led to a decrease in operating margin (to 19% from 20% last year). While total results were less sanguine than we anticipated (forecasting high-single-digit sales growth), we don't believe the final quarter is likely to follow suit. In fact, we expect the holiday season to remain promising for Hasbro, thanks to partner brand demand stoked by the launches of Frozen 2 and Star Wars: The Rise of Skywalker.

We view shares as overvalued even after trading off more than 10% on the initial print, still at more than 20 times our 2019 earnings per share estimate. We plan to increase our $92 fair value estimate by a mid-single-digit rate, with about a $7 increase stemming from the closure of the Entertainment One, or EOne, acquisition during the fourth quarter and around a $1-$2 drag from third quarter concerns that persist only through the fourth quarter. While the more than CAD 1 billion in sales and CAD 200 million in operating income in 2020 from EOne lifts our profit outlook, much of the potential near-term gain is offset by higher debt service costs until Hasbro begins to deleverage its balance sheet. Some deleverage should occur through EBITDA gains, with sales set to rise 5% organically annually between 2020-23, helping Hasbro return to its 2-2.5 times debt/EBITDA goal by 2023. We believe a fair amount of integration risk remains from digesting a transaction of this size, given the $4 billion price tag relative to Hasbro's $15 billion market capitalization.

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