Are you aware of the Elsa and Anna phenomenon? The executives at Mattel, Inc. (Nasdaq: MAT) are. They’ve watched their once-popular Barbie doll lose appeal as young girls switch allegiances to the new dolls based on the popular children’s movie, “Frozen.”

Barbie’s steady demise was one of the factors behind the January 2015 resignation of CEO Bryan Stockton. He took the reins of the company in November 2011, and though shares initially rose in the first few years of his tenure, they subsequently went into freefall. 

After such a sharp drop, shares of Mattel are inarguably cheap. They sport a 7.6% dividend yield (more on that later), and trade for just 1.2 times trailing sales, compared to a 2.1 multiple for rival Hasbro (Nasdaq: HAS). Hasbro now has a greater market value than Mattel for the first time in more than 20 years. 

Low valuations don’t make a stock inherently appealing, unless they are accompanied by a good turnaround plan. And that is just what new CEO Chris Sinclair has offered up to investors. Since becoming CEO of the company earlier this year (losing the “interim” tag in April), Sinclair has taken a close look at every aspect of this flagging business model, and his early efforts are already bearing fruit. Operating costs, for example, fell 10% in the most recent quarter, compared to a year ago. That led to a surprise Q2 profit, while analysts had been anticipating a loss. By the time his streamlining efforts are complete, Sinclair aims to shed $250 to $300 million in annual operating expenses.

Mattel Has Already Shown Success In Reviving Classic Brands
While Sinclair focuses on the cost side of the business, Richard Dickson, who was recently promoted to president, is tasked with rejuvenating Mattel’s brands while developing new ones. Of course he’s squarely focused on the Barbie brand. And Dickson thinks her obituary is premature. “Our research shows that the brand’s relevance and interest among girls has been improving as a result of more effective marketing and more exciting products,” he said on a recent conference call. 

Notably, Dickson oversaw a revival of the Barbie franchise a decade ago before eventually leaving the company for an opportunity to be CEO of an apparel retailer. He now aims to bring Barbie into the 21st century, imbuing the doll with the ability to interactively communicate with children. 

Mattel also aims to give Barbie some company, adding superhero-based dolls such as Wonder Woman and Superwoman to the mix. More broadly, Dickson aims to inject advanced technologies into many of Mattel’s core brand platforms. 

One of Dickson’s boldest moves: The creation of a standalone unit known as “Toy Box,” which is filled with creative types that can pursue new ideas without too many layers of bureaucracy. Mattel is the textbook antonym of a “start-up,” and a bit of risk-taking and entrepreneurialism in the creative team is precisely what this company needs.
    
Make no mistake, this company still possesses very powerful brands. Beyond Barbie, Mattel also controls Fisher-Price, Hot Wheels, and MatchBox, as well as a broad line of popular board games and dolls. That enables Mattel to capture a large amount of retail shelf space, a key factor behind all-important holiday sales.

Those brands also increasingly have global appeal, gaining traction in markets such as China and Russia. To be sure, the strong dollar is impeding results in the international division right now, but Mattel should benefit over the long-term from the aspirational purchases of American-branded products by the emerging global middle class. “There is much upside opportunity for us in emerging and developing markets and we are moving strategically to seize it,” says Dickson. 

Mattel’s industry heft also means that it can still sign major contracts with top image makers. In recent quarters, Mattel has signed new agreements with Nickelodeon, and DreamWorks Animation (Nasdaq: DWA). The company is also developing a new line of toys based on an upcoming Netflix (Nasdaq: NFLX) children’s TV series called “Daimler Trucks.” 

Management Is Keeping Its Focus On Cash Flow
Now, back to that juicy 7.6% dividend yield I noted earlier. It may need to be reduced in coming quarters so management can direct greater financial firepower at the company’s turnaround efforts. 

However, the market may be wrong in anticipating a dividend reduction. “We are managing our margins effectively and we are generating ample liquidity to fund our turnaround efforts and to maintain our $0.38 a share quarterly dividend,” said CEO Sinclair on the company’s most recent conference call.
Regardless of whether the dividend is reduced in the near-term, Mattel’s strong cash flow means that the dividend would likely be returned to current levels once the turnaround spending is complete anyway. 

Judging by the lagging stock price, it may seem overly-optimistic to be focusing on a turnaround. Oppenheimer’s respected toy analyst Sean MacGowan notes that lingering pressures related to a slow global economy are “masking what we believe are emerging signs of improvement,” adding that he is taking “the longer-term view, and remain(s) positive on the stock’s prospects for 12-15 months from now.”

In a nutshell, this is how turnarounds tend to play out. Management starts to pull a range of levers that only bear a little fruit in the near-term, leading shares to continue to languish. Yet as results start to strengthen, investors start to take note of appealing valuations, robust dividend yields, and rising cash flow. For Mattel, that backdrop is just now coming into focus. 

Mattel will report Q3 results on October 15. At that time, listen for management’s expanded commentary around the company’s turnaround efforts. There may just be enough “green shoots” that enable investors to again focus on the long-term upside for this beaten-down stock. 

Risks To Consider: Mattel faces a changing landscape for children’s entertainment. Management must tailor the still-strong brands to modern, technology-oriented platforms.

Action To Take: Every year, investors are presented with the chance to buy solid but struggling businesses. The key is to focus on such businesses that have a clear path for a turnaround. Mattel is pursuing a textbook business revamp that should greatly enrich shareholders in the next 12 to 18 months.

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