"Chinese Bargain" May Become Very Expensive -- Mattel Takes a Hit on Toy
Recall

August 2, 2007, 2:07PM EST text size: TT

Mattel Takes a Hit on Toy Recall

While some Wall Streeters don't think the move will harm the toymaker's
long-term profits, one analyst frets about litigation risk

by David Bogoslaw

Shares of Mattel (MAT), the world's leading toy maker, held up fairly
well after the company said on Aug. 1 that it was voluntarily recalling
about 1.5 million toys made by a long-time supplier in China that were
produced using a non-approved paint pigment containing lead, which
violates industry and Mattel's own self-imposed standards.

Mattel said it will take a pre-tax charge of $30 million against its
second-quarter earnings to cover the financial loss from the recall. On
July 16, the company reported a profit of 11 cents a share, compared
with eight cents a share in the second quarter of 2006, on a 6.5%% rise
in global sales.

Mattel's shares were down 2.3%% at $23.04 in early afternoon trading Aug. 2.

The recall is on certain Fisher-Price products sold between May and
August 2007, including characters popular among pre-schoolers such as
Elmo, Big Bird, and Dora the Explorer. Roughly 500,000 of the products
have been sold to consumers, while the remaining one million are still
in the hands of retailers, equities analyst Margaret Whitfield at Sterne
Agee & Leach said in an e-mail to BusinessWeek, after speaking with the
company. (Sterne, Agee & Leach has done investment banking with Mattel
in te past 12 months and makes a market in its securities.)

The El Segundo (Cal.) company said that after detecting the unsafe lead
levels in the last few weeks, it launched a fast-track recall, working
with the U.S. Consumer Product Safety Commission and other regulatory
agencies around the world. It also said it's helping retailers to
identify affected products, remove them from retail store and intercept
further shipments and prevent them from being sold.

The news is the latest in a series of reports of unsafe ingredients used
by Chinese suppliers in the production of seafood, toothpaste and
medicines exported to the U.S. and other countries. Perhaps the most
infamous of these concerned contaminated elements found in a wide range
of pet food brands, which were linked to a number of animal deaths
earlier this year. But toy manufacturers have also come under scrutiny
since RC2 Corp.'s (RCRC) well-publicized, voluntary recall in June of
1.5 million wooden railroad toys and set parts from its Thomas & Friends
Wooden Railway product line.

The problems have eroded consumer confidence about Chinese imports and
prompted a new resolve by the country's commerce officials to regain
trust among China's trading partners.

Mattel said it's investigating the reasons for using unauthorized paint
but has already restarted production at the supplier and estimates it
may take only a week to restock shelves, Whitfield said in her e-mail
message. The plant in question has no prior history of violations.

"With annual sales of around $6.0 billion, Mattel ships literally
hundreds of millions of individual items, so a recall of one million
units is hardly material relative to total sales," Wedbush Morgan
Securities analyst Sean McGowan said in a research note.

While the immediate financial impact is probably contained, the company
could take further hits down the road as a result of litigation risk,
though there have not been any specific reports of affected children,
Standard & Poor's said in a research note. The research firm trimmed its
2007 earnings estimate for Mattel to $1.60 from $1.64 a share and cut
its 12-month target price to $27 from $29.

Given the seriousness with which Mattel takes safety issues and the
importance of consumer perception, the company is likely to treat the
matter with the highest urgency and won't settle for the cheapest
solution, the Wedbush note said. (Wedbush has no investment banking
relationship with the company.)

McGowan said he doesn't expect the recall to cloud investors' views of
the company in the long term or to have a recurring impact on Mattel's
profits. He maintained his buy rating on the stock and a target price of
$32, based on a price-to-earnings multiple of 17 times.

Mattel faces other challenges as well. In an effort to combat the
encroachment of computerized toys into its targeted consumer base, the
company has recently introduced new product lines such as an MP3 player
to be used with its BarbieGirls.com web site and the Radica line of
electronic devices.

http://www.businessweek.com/print/investor/content/aug2007/pi2007082_041591.htm