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SECTOR SCOPE by James A. Anderson December 6, 1999

The Toy Biz Is a Tough Game for Investors
Despite the holiday sales rush, December is usually a down month for toy stocks. Here's why

There's a strong dose of holiday spirit in the malls this year. Droves of shoppers are shopping. Flocks of Furbies are chirping. Packs of Pokemon are a-selling, and the movie Toy Story 2, while perhaps not perched in a pear tree, is sitting pretty at the box office.

It may seem like time to invest in the corporate version of Santa's workshop, despite the well-publicized problems that beset Mattel (MAT), the largest company in the group. Preliminary sales figures show the holiday shopping season off to a respectable start. And indications are that toy makers will record a 7% gain in revenues for all of 1999, vs. a more normal 4% or so for the past decade and 1998's anemic 2% increase. Videogame makers are enjoying even better times: Some companies in the fast-growing segment will log sales increases of as much as 32% this year, according to analyst Sean P. McGowan of Gerard Klauer Mattison.

Just remember this: Toy stocks tend to get scuffed up every December. Over the past five years, shares of toy manufacturers have lost an average 2.2% during the month, according to calculations by Gerard Klauer Mattison. Videogame stocks have shed an average 11% the last 31 days of each year since 1993. The explanations for why that's so usually range from a premature bout of post-holiday letdown to the notorious inconsistency of toy demand to the fact that even hit playthings have a shelf life that's about as long as the attention span of their young audience.

LOST TOT APPEAL. To top things off, McGowan thinks sales of toymakers will slacken in 2000 to the normal 4% increase, as some hit gadgets lose their tot appeal. The bottom line: If you're shopping for a toy stock, you might be wise to wait until later in the month and choose a company that will prosper next year.

Speaking of inconsistency, look at how skittish the shares of some of the biggest names in the business have been. First, there's Hasbro. It sells Star Wars action figures, Pokemon-related toys, and could be jolly if Furby sales jump to $300 million this year, as some analysts estimate. Yet, Hasbro shares have slipped some 10% since January.

Another disappointment is Toys 'R' Us (TOYS), once a retailing kingpin, which is battling Wal-Mart (WMT) for No. 1 in the toy biz. Toys 'R' Us shares have slid some 3% so far this year. And no doubt, you've heard of Mattel's woes. What with Barbie losing her allure and Mattel's acquisition of The Learning Company hurting results, Mattel's stock is off 40% year-to-date. Even some stocks in the generally flush videogame business, such as Activision and Acclaim Entertainment, are off more than 40% so far in 1999. With a new Sony Playstation in the works for next fall, the changeover has the Street worried that videogame sales and earnings might be disrupted for many competitors.

BIGGER THAN TINSELTOWN. Nonetheless, there's no better place to be in the toy store than the videogame aisle. Analysts think the group's sales will rise 20% to 25% annually over the next five years. "You have to be bullish on a group like this," says Edward S. Williams, who follows videogames for Gerard Klauer. "The market is north of $8 billion in 1999, which makes it larger than Hollywood in terms of box-office receipts." Still, it pays to be wary. Some of the hottest titles, after all, tend to flame out after a year on toy-store shelves.

The key is to put your money on companies with strong managements and strategies tailored to the biggest growth vehicle around: the Internet. Candidate No. 1, at the moment, is Electronic Arts, which recently announced that it will start an online division and link up with America Online to provide fun and games for the AOL's interactive entertainment site. Better yet, Electronic Arts has said it plans to create a tracking stock for its online ventures. Startup costs will likely keep earnings flat for a couple of years. But Williams estimates that Electronic Arts' could derive as much as 20% of its annual revenues from the Net by 2003.

"Electronic arts is a story that's about more than just one title," says Bear Stearns analyst Marina Jacobson. "The company is doing quite well with a portfolio sports titles, like Knockout Kings and Madden football, and its Internet game sites could become one of the stickiest Web communities around." Jacobson thinks that Electronic Arts, which closed on Dec. 3 at $109.56, could hit a target price of $135 within 12 to 18 months. All 13 of the analysts who cover Electronic Arts rate the company a strong buy or buy. Wall Street projects that the company's earnings should grow 23% a year over the next five years, according to Zacks Investment Research.

HASBRO HITS. As for traditional toymakers, it's a no-brainer to skip Mattel until Barbie's parents figure out why the doll is no longer the most popular blond on the block and until it resolves problems in its boardroom. Hasbro looks like a good pick, however: It owns such brands as Tonka, Parker Brothers, Milton Bradley, and Playskool, not to mention its menagerie of Pokemon-related products. In fact, Hasbro has been the biggest of a dozen or so beneficiaries of Pokemon fever, says Gerard Klauer's McGowan. He estimates that sales of trading cards of the fictitious beasts will hit $450 million this year for Hasbro and $600 million in 2000. On top of that, Pokemon toys and other knicknacks should rack up retail sales of $250 million this year and $585 million next.

Hasbro has had a ho-hum year mainly because Wall Street expected more from its Star Wars licenses. "Some investors got caught up in unrealistic estimates," says John P. Miller, an analyst for Ariel Capital Management, who thinks many investors abandoned the stock prematurely when Hasbro didn't meet some of the more aggressive projections for it. "The company still looks good to us," he adds, "especially its board games, which are Hasbro's cash cow." Hasbro is rated a strong buy or buy by seven of the eight analysts who follow the stock, and the Street expects the company to post 14% average annual earnings growth over the next five years, according to Zacks. McGowan says the stock, which closed at $20.81on Dec. 3, could reach $30 in the next 12 to 18 months.

Mutual funds devoted entirely to toys just don't exist. One reason: The sector's results fluctuate so much that companies offering sector funds more often than not lump playthings with other leisure products, if only to even out total returns. One proxy worth considering is Stein Roe's Young Investor Fund (SRYIX). The fund looks to invest in companies whose products and services touch children's lives -- including toys. The fund has a 2.5% weighting in the toy sector, down from a 3.5% holding a year ago because the prices of both Hasbro and Mattel have slid. All the same, Young Investor has tracked the market pretty well, with a 22.87% average annual return over the past three years. The fund is up 26.45% so far in 1999.

James Anderson teaches journalism at the City University of New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

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