Hasbro Share Repurchasing: Follow-Up

Back in February, I wrote a blog post about Hasbro Inc.'s use of free cash flow to repurchase shares, and how sometimes the amount of shares repurchased approached or exceeded the company's free cash flow. I'll admit that I initially panicked at my findings, as I was about to make a purchase of Hasbro shares. On the advice of a friend, I did some further investigating on the issue, and I am now writing this blog post to summarize my findings.

I spoke with Hasbro investor relations, and they were very helpful in providing me with details of Hasbro's policies on use of free cash flow. Hasbro generates a healthy amount of cash, and there are multiple options for what to do with that cash. According to investor relations, Hasbro's first priority is to reinvest in the business, typically in the order of tens of millions of dollars. Acquisitions are an option, however they are not typically pursued as the value obtained is not sufficient, but intellectual property is sometimes purchased. Cash could be used to pay down debt, however Hasbro makes use of "good debt" that is manageable and adds to the business's ability to operate. If you take a look at Hasbro's annual balance sheets, their total current liabilities are typically less than their total long-term debt.

At Hasbro, it is a tradition to return cash to shareholders. Hasbro has maintained or increased their quarterly dividend every year since 2002. Hasbro has been buying back shares for a long time, and continues to do so under their current authorization since 2005. Hasbro's reason for buying back shares is to offset dilution of shareholder value as a result of stock-based compensation of management, and to buy back shares over and above that offset in order to increase shareholder value. Hasbro does so opportunistically to take advantage of low share pricing at times. Typically in the past and going forward, Hasbro does not use debt to repurchase shares.

If you look at the table in my last blog post, the only year in which Hasbro spent more than 100% of their free cash flow to repurchase shares was 2010. According to investor relations, this was to offset the conversion of a convertible debt offering issued in 2001 into common stock. Hasbro's net change in cash for 2010 was +$91.75 million, even though it repurchased $546 million of common stock. Hasbro also took on debt that year to raise cash. I had read through multiple annual reports dating back to 1997 from Hasbro in search of why this particular year was so aggressive in terms of share repurchases. I found multiple references to convertible debentures and share repurchases, but I did not find any mention of their connection to each other.

In terms of whether Hasbro believed its shares to be undervalued when purchasing them, the only answer I found was an average price quote for a time period that I should have written down but must have missed, and that purchases were opportunistic.

All in all, I've accomplished some in-depth research on Hasbro, and it was my first time calling the investor relations department of a public company. Hasbro seems to care about share dilution and seems dedicated to returning cash to shareholders, while growing its core brands and operations. I'll mull over Hasbro a little longer, but I don't want to over-analyze it.

An Austrian School Contradiction: Revisited

In my previous blog post about Austrian School beliefs regarding price fixing and the gold standard, I described how fixing the rate of change in price is essentially the same as setting simultaneous floor and ceiling prices. This is technically untrue, since a rate of change implies the involvement of a time variable, however my floor and ceiling price limits have nothing to do with time. In other words, the price of a good can fluctuate between those price limits as quickly or as slowly as it may. All the price limits accomplish are a minimum and maximum absolute value difference between a good's starting price and its ending price, whichever point in time that may be.

Price limits aside, I was reading through a blog post on Mises.org ("Is Inflation about General Increases in Prices?") and realized that I may have misinterpreted some Austrian School beliefs, as I suspected I might have at the end of the last blog post.

The key difference that I failed to distinguish previously was that inflation is dilution of the money supply, not an increase in size of the money supply. For example, if gold is the medium of exchange in an economy and someone mines more gold, he is participating in the market's demand for gold. If he decides to cheat and dilute the money supply by melting down gold coins and reproducing them with less gold content, or by printing extra gold recipts (paper money), this person would be using the new "money" to buy something for nothing. In other words, he did not exchange wealth for wealth, he exchanged nothing for welath, which leads to a misallocation of resources in the economy.

This one paragraph doesn't do the concept justice, so I suggest you read through the original Mises.org article. In conclusion, Austrian School advocates of a gold standard aren't trying to regulate the size of the money supply; they are trying to control dilution of the money supply. Having real gold as the medium of exchange makes it much more difficult (although not impossible) to dilute the money supply than if the medium of exchange were a fiat currency (as we have today).

Giving Cash Back To Shareholders is Nice... When You Can Afford It

Over the past few weeks, I've been looking at various stocks trying to find my very first Warren Buffett-style value investing stock pick. One of my main considerations was Hasbro, Inc. Hasbro has a lot of brand power under their belts: Monopoly, Battleship, Boggle, Pictionary, Risk, Scrabble, Trivial Pursuit, Transformers, Nerf, not to mention more targeted brands such as Magic: The Gathering and Dungeons and Dragons. I went to Zellers the other day and took a stroll through the toy section. Many of the toys were made by Hasbro, meaning that Hasbro has a lot of retail store shelf space at stores like Wal-Mart, Zellers, Toys R Us, and so on. Hasbro has also been diversifying their brands toward movie production, such as Transformers and G.I. Joe. Upon examining the management, I found that the CEO of Hasbro personally heads the Corporate Social Responsibility Committee, a task that could easily have been delegated to a sub-manager. To me, that shows that the CEO actually cares about what goes on at those committee meetings.

When considering Hasbro's financials, I found a lot that matched a checklist I've built, based on reading how value investors like Warren Buffett pick stocks. Hasbro has low capital expenditure, consistent profit margins, return on assets in the 9-10% range, growth in net income and growth in what Buffett calls "owner earnings". Owner earnings, or free cash flow, are equal to the company's net income, plus depreciation/amortization, minus capital expenditures. Since depreciation/amortization are a non-cash expense, the cost is added back in to the equation, and offsetting depreciation/amortization is taken into account by subtracting capital expenditures. The result is the amount of cash that the company can decide to re-invest in the business, use to acquire other companies, or pay out to shareholders in the form of dividends or share repurchases.

Something Buffett likes to see in a stock is good treatment of shareholders. At the time of this writing, Hasbro currently has a dividend yield of just over 4%, which is pretty good. They also have an on-going share repurchase program. Since 2008, Hasbro has repurchased about 10.6 million shares. The result has been a steady increase in earnings per share. After valuing Hasbro's future cash flows with a modest 5% growth per year, I came up with a valuation of the company that is higher than its current share price, offering a margin of safety around 25%. If I were to assume a higher growth rate, that margin of safety would be larger, but I don't want to over-estimate. In any case, I had all but convinced myself that this stock would be a good buy, according to the value investing principles I have been learning about. The only reason I haven't purchased this stock yet is that I'm still waiting on transferring my RRSP account over to a self-directed account that I can use to buy individual stocks. Perhaps this was a blessing in disguise.

Buffett says that when you find a good investment, you should place a sizeable chunk of cash on it. Since I would be placing a sizeable chunk of cash on Hasbro, I want to be sure that I'm right about its prospects. After all, the whole strategy of focus investing is simply to just buy good companies, and avoid bad ones. I wanted to make sure I wasn't buying a bad one. It seemed strange to me that shareholders were being so lavishly rewarded year after year with dividend payouts and share repurchases, when news pieces on Hasbro had such a modest or grim outlook. I whipped up a quick spreadsheet, and here is what I found:

Data taken from Google Finance

From what I see in the spreadsheet, Hasbro has been paying out more than 100% of its owner earnings to shareholders! At the same time, it has been borrowing hundreds of millions each year. It looks to me like this is unsustainable. Cash should only be paid out to shareholders if it can't be better used elsewhere to grow the company and add value for shareholders. From what I can tell, at least some of the cash being borrowed and/or paid out to shareholders could probably be better used by re-investing in the business. This realization has led me to reconsider my plans to purchase shares in Hasbro for the time being.

Edit: I did some follow-up research on this topic, and wrote a blog post summarizing my findings.