Spin Master Corp. Is Spinning Out of Control

Spin Master Corp. (TSX:TOY) pulled back a whopping 5% this Wednesday on news that its biggest toy, Hatchimals, is facing a major backlash from customers of defective units. Many units either won’t hatch or die shortly after hatching. To add salt to the wound, the customer service experience is described as a nightmare, as many parents have been waiting up to three hours on the phone before getting disconnected.

In my previous article on Spin Master when the stock was at its all-time high of $38, I made it very clear that the company was experiencing manufacturing inefficiencies and could pull back as a result.

Initially, the company could not keep up with the high demand for Hatchimals, and this meant a ton of lost sales. But now there’s a concern with the quality-control part of the manufacturing process. These defective units are going to have to be replaced, and right now it looks like the company is in way over its head, as it is still trying to manufacture new units for the new year since demand is still sky high.

As a Foolish investor, you have to ask yourself why you’re buying into a stock at its all-time high. If you did buy the stock above the $34 level, then you probably bought on news that Hatchimals was a success story.

You should never buy a high-flying stock like this based on one product. The company has had a single source of failure, and now investors are realizing the importance of revenue diversification. Sure, there are other great brands and fantastic toys, but Hatchimals is the hot toy in town and the major driver of the stock.

There’s no question that the company can innovate. Spin Master knows how to develop toys that kids want, and I believe it will always have this expertise.

The only problem is that the manufacturing process needs major improvement. Not being able to keep up with demand is a big turn-off, but the poor quality control, as demonstrated by the large amount of defective units, is completely unacceptable. The manufacturing inefficiencies have got to change, and it’s clear that the management team doesn’t know this part of the business very well.

It’s a big shame that such a fantastic toy with high demand couldn’t deliver due to manufacturing issues. The stock would have soared to new highs in 2017 if the manufacturing part of the business could keep up with the innovation and R&D side of the business. I suspect the stock will continue to pull back below the $30 level, as Spin Master attempts to improve both its customer service and manufacturing parts of the business.

If you’re an investor in the stock, then now is the time to sell because the headwinds are too great right now, and the next few quarterly reports will disappoint. There’s a lot more downside left for the stock. I would caution investors thinking about catching this falling knife.

Remember, don’t buy into the hype, especially at all-time highs. If you’re buying a stock because of a single product, then you’re taking a huge gamble because that means there’s a single point of failure. Let this be a lesson learned.

Stay smart. Stay hungry. Stay Foolish.

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Fool Contributer Joey Frenette has no position in the companies mentioned in this article.

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