FNKO - Funko Stock Rises 20% On Q1 2023 Results: Will The Uptrend Last?

2023-05-12 06:50:41 ET

Summary

• Funko reported $251.88 million in revenue for Q1-2023, beating expectations by $13.24 million.
• The company’s sales decreased YoY and its net loss increased.
• The company is still recovering from overstock issues and increasing costs reported in Q3-2022.
• The company’s stock price underwent two extreme downtrends over the last twelve months.
• I rate the stock as a hold for now but expect Funko’s financial performance to improve over 2023.

Funko ( FNKO ) beat market expectations in its recent Q1-2023 financial report and shows signs of recovery from previous under performance. To be clear, the company's financial results reveal slow signs of recovery, but its 2023 guidance was impressive enough to cause a rally in stock price. The company's stock price saw a 20% increase around its Q-2023 report. The rally occurred on the news that Funko expects better performance over 2023 in terms of inventory numbers, gross margin, and net loss. I rate the stock as a hold for now and recommend investors watch the company's financial performance over the year.

Business Operations

Funko is famous for its highly collectable vinyl bobble-head figures (Funko POP!), which are available everywhere and feature characters from the hottest entertainment licenses, like Disney (DIS), Marvel Comics, and Star Wars. The figures are so sought after that there is a robust secondary market for the resale and purchase of its products. Funko's special run bobble-heads often sell out and become hard to find. The company admits that extreme fandom is part of its business strategy. It holds a massive portfolio of entertainment licenses, including characters from comic books, movies, cartoons, music, sports, and video games. Funko releases vinyl figures throughout the year that mirror entertainment and pop culture trends.

The company produces more than just vinyl figures. It sells another collection of merchandise under the Loungefly brand, which makes backpacks, wallets, purses, and enamel pins. The items feature scenes and characters from popular movies, tv shows, animations, and other entertainment genres. Besides Loungefly, Funko makes games and toys, which may be found on the toy aisles of big box stores. The company makes blind box vinyl toys, like Funko Soda and Mystery Minis, and it releases a monthly NFT series on Atomic Hub, which has physical redemptions. The company's product offerings are vast and robust.

Funko drives fandom by releasing special run products at its big box outlets and online. The company's merchandise may be found at Walmart, Target, Amazon, Hot Topic, Box Lunch, GameStop, FYE, and other big box retailers. Funko offers special run products from its online shop, as well as its physical POP shops. Funko caters to its fanbase by attending pop culture events like comic book and toy conventions. Funko has operations and sells its collectables globally, with large markets in Europe and Asia.

In its recent Q1-2023 report, Funko cited new products which are driving revenue growth. The company introduced a miniature POP series, called Bitty POP, which are about 1" in height and come in packs of four figurines. The company also enjoyed growth from its merchandise around the popular Japanese animation series, One-Piece. In addition, Funko has recently partnered with Fanatics to make new sports collectables.

Recent Financial Performance

The popularity of Funko's products and its large distribution footprint may be seen in the company's revenue break down.

The company has experienced a decline in sales YoY. The decline comes after the company almost doubled its revenue numbers. The collectables market seems to be cooling down a bit. During the COVID pandemic and subsequent lockdowns, online sales of collectibles massively increased. In the post pandemic economy, collectables buying has decreased. In response, Funko plans to produce less merchandise. The company must find a new equilibrium between production and demand.

The company's popularity during the pandemic and afterwards, may be seen in its yearly revenue totals.

Source: Seeking Alpha

The revenue totals doubled by 2022, but cost of revenues also increased. The balance between production, demand, and operating costs became unbalanced, which left the company with high inventories and increasing net loss.

The dilemma was first announced in Funko's Q3-2022 report (Nov. 2022), which showed record breaking revenue numbers and should have been received as excellent performance. The stock fell over 50% at the time because of the company's downgraded future outlook and slowing growth. Beyond the revenue numbers, the company reported a net income which represented a 39.3% decrease YoY. The company missed on EPS and its full year revenue guidance showed little improvement from the last year. The company warned that gross margins would decline due to overstock and rising costs from inflation. The news dropped the company's stock price from around $22 per share to $7 per share. The price ultimately restabilized around $11 per share.

The company announced in the same report that choppy waters were ahead for its financial performance. Funko's next quarterly report ( Q4-2022 ) showed more loss than expected and the stock once again fell 25%, returning to the $7 price channel. The company reported that gross margin had fallen by 560 basis points YoY and that inventory had grown 48% to $264.4 million. The company planned an inventory write down of $30 million during Q1-2023. Funko revised its revenue expectations for the next quarter and admitted that its EBITDA would be a loss for a part of 2023. After the news and the stock price downtrend, the stock price ultimately restabilized at around $9 per share.

Q1-2023 Financial Performance

The company released its Q1-2023 results in early May. Its performance beat expectations, in both EPS ($0.49 beats by $0.43) and revenue ($251.88M beats by $13.24M). The news caused the company's stock to rally back to the $11 price channel. With a one-time $30 million inventory markdown, the company reported a gross margin of 19.7% compared to 35.5% YoY. The margin would have been 32% without the write-offs. Funko's net loss had widened to $61.1 million, representing a 521% increase YoY, and its net sales decreased to $251.88M, representing an 18% decrease YoY. The company announced that its inventories had been reduced and that sales were expected to decline over 2023. The stock rally occurred because the company promised a positive EBITDA by the end of 2023.

Funko showed an increase of 61% YoY in e-commerce or direct-to-consumer sales. The company has recently offered its big box retailer exclusives on its website. Fans may buy these exclusive items direct from Funko instead of going to the big box locations. Funko forecasts Q2-2023 revenues to be between $240 and $260 million. The company predicts a net loss between $24 and $16 million. Funko confirms that net sales will decline between 10% and 5% over 2023. It foresees an improved gross margin over the year. Inventories remain high at $191.6 million, an increase of 18% YoY, but a decrease of 22% from the previous quarter.

The following chart shows the company's earnings over the last five quarters.

At the beginning of 2022, the company saw an extreme increase in sales, which stayed strong until the first quarter of 2023. The margins fell during the last quarter of 2022 and first quarter of 2023. Net income fell into the negative and has increased in the wrong direction. The company's performance will be impressive again when these numbers return to equilibrium. Revenues do not have to increase, but gross margin and net income need to improve. The company is currently attempting to right-size its operations in order to bring its income statement back to profitability. When it occurs, likely at the end of 2023, then a buy signal will emerge.

Stock Price Performance

The following chart shows Funko's stock price performance over nine months.

The stock had seen a high around $27 per share back in August 2022. The company's November 2022 reports and the larger issues of high inflation and rising interest rates caused the stock price to crash. Momentum for the stock has remained high, perhaps because there is high institutional ownership of its shares. The price priced went back up and maintained higher channels until the company's March 2022 reports. At that time, the price crashed again and restabilized. The report in May 2022 caused a rally and an increase of 20%. The stock is currently remaining in the $10-$11 price channel. Its one-year performance is negative 41%. Better financial performance from the company may bring the stock price to higher channels. Larger market conditions are playing a role in the stock's volatility. The issues of inflation and rising costs have a negative effect on Funko's operating costs, as well as on the consumers' expendable cash. It is unclear whether the stock price will return to its glory days of $20 to $25 per share. A buy signal may occur if the stock continues it uptrend and the financial results improve.

Conclusion

The change in demand in the collectables market as well as other market factors caused Funko's excellent financial performance to change direction. The company found itself with too much inventory and had to write down $30 million in merchandise. Hopefully the company can find a better a proportion between costs, production, and sales, which brings it back to net gains. Meanwhile, the company's stock price has been on a wild ride with some recovery. Since larger market volatility promises to remain, Funko's stock price will continue its uncertain movements. I rate the company as a hold and recommend that you watch its future financial performance.

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