FNKO - Funko Dumping Inventory Is A Bad Sign

2023-03-09 04:28:18 ET

Summary

• Funko is dumping $30M in inventory to save costs.
• It's a sign the company's products aren't selling.
• The Q4 financials are bleak.

Funko ( FNKO ) is heading to the dumps. Literally. The company is dumping over $30M in inventory of its once popular figures into a landfill in order to cut costs.

Shrinking Margins

Manufacturing stocks don't typically carry high margins and Funko carries an additional cost many of the successful ones like Apple ( AAPL ), Tesla ( TSLA ), and Deere & Company ( DE ) don't have to experience.

Licensing content from Disney ( DIS ) and sports leagues comes at a hefty cost. I always tell investors who get excited when a company like Funko partners with the NBA or NFL that the owners of these teams are some of the most savvy business people on earth. They always get the best of any business deal.

Looking at Funko's gross margin compression over the past few years, it's not pretty.

Source: Funko Press Releases

Funko noted that storage costs drove down margins in the most recent quarter, hence the dumping of inventory. However, investors have to start to wonder where the operating leverage is going to come from with Funko? The licensing partners likely won't meaningfully reduce royalties and raw materials, shipping and labor don't tend to go down over time either.

Q4 Financials

The Q4 financials paint a bleak picture for Funko. Revenues declined 1% Y/Y, although that was more or less expected by Wall Street.

Unfortunately, operating expenses increased $80M and swung the key holiday quarter to an operating loss of $58M. More alarming is the company's interest expense accelerated to nearly $4.5M in the quarter - more than half of the $7.2M it paid in net interest for all of 2021.

The asset side of the balance sheet is on the verge of distressed levels. The company has seen its $84M cash pile in 2021 shrivel up to just $19.2M. Most of that cash appears to be sunk into inventory - which rose from $166M last year to over $246M this year. While building inventory is not always a bad thing, the fact that Funko is dumping the inventory into a landfill after a holiday shopping quarter is alarming.

The liabilities side of the balance sheet shows how dire the situation could become for Funko. A new $70M line of credit appears to go along with $153M in debt - well in excess of the companies $19.2M cash balance.

Unfortunately operating cash flow doesn't get any better. After rather sensational results in 2020 and 2021 - the most recent year saw operating cash flows turn negative to the tune of $40M.

If Funko can't reverse the trend in 2023, the company has just 6 months of cash left on the balance sheet. Yes, the company does have a hefty amount in receivables ($167M) so it's not time to dial up a Chapter 11 bankruptcy attorney yet. However, one has to wonder if the company is dumping inventory into landfills - how much demand will reappear in the coming year since it's likely retail partners are sitting on dead inventory too?

Turnaround?

Luckily Wall Street is bullish on a turnaround in just a few quarters for Funko. Looking out, analysts are anticipating double-digit revenue growth to return in Q4.

Will discretionary spending on Funko's products not only return dollar-for-dollar, but reaccelerate in Q4? Seems like a difficult question to answer at the current time given the macro environment. Certainly if you believe Wall Street, Funko trading at 0.33x 2023 sales is not a wildly overvalued stock considering Mattel ( MAT ) is trading at a multiple closer to 1x.

Bottom Line

The collectibles space got a huge bump during the pandemic as consumers got large amounts of stimulus and had more discretionary income because they couldn't travel or eat out.

As inflationary pressures are driving up cost of living expenses, more Americans are living paycheck-to-paycheck. The same studies show even six-figure earnings are stretched too thin as well.

If you believe this reverses itself sometime this year, then I suppose Funko would make a rather speculative, but rewarding investment given the valuation.

However, any continuation of inflationary pressure on consumers likely means Funko's outlook is too rosy. Further, one has to wonder if the novelty of Funko's products is wearing thin considering the company can't sell through inventory.

I would avoid Funko until the company can prove it's going to survive the downturn. The stock isn't widely covered so a prudent investor can wait for signs of the turnaround since the risk of a complete wipeout could materialize given the bleak financials.

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