2023-08-09 05:32:26 ET
Summary
- JAKKS Pacific is a multi brand toy company focused on evergreen brands through its licensing partnerships with Nintendo, Disney and others.
- Q2 revenues down 24% due to market trends, however, improving inventory turns while increasing gross margins and debt free makes them perfectly resilient in challenging times.
- It trades at a dirt cheap valuation of under 5x Fwd P/E, and we believe the continued resilient operational performance will drive rerating. Initiate at Buy.
Investment Thesis
JAKKS Pacific ( JAKK ) is a multi-brand toy company that produces and markets toys and related products including action figures, toy vehicles, dolls, costumes, kids indoor and outdoor furniture and others. It licenses evergreen brands from Disney, Nintendo, Nickelodeon and others providing a wide range of action figures, toys and dolls such as Mario, Disney Princess and Sonic Prime that makes them relatively insulated against market fads. It was a key beneficiary of the COVID pandemic as kids staying home had led them to buy more toys to avoid boredom. However, with reopening of schools post pandemic, the trends have normalized and the shares have tumbled by a fourth after topping $25 mark last year. At the current valuation, the stock remains dirt cheap and its debt free position and resilient business model provides a favourable risk reward.
Earnings Corner
JAKK reported a 24% decline YoY in revenues for Q2 driven by declines across toys/ consumer products (21% decline) and costumes (31% decline). Costumes decline was on anticipated lines as it was lapping an exceptional quarter which had record shipments in last 10+ years as a result of pent-up demand due to reopening. US toys market remained weak due to the current uncertain environment which declined 26% partially offset by 12% increase in the international markets. The toy segment was primarily driven by the Super Mario movie which grossed about $1.3 bn so far since its release in April helping its Mario and Nintendo classic line. Gross margins expanded by 310 bps YoY to 30.7% driven by record product margins which expanded 370 bps YoY to 48.4% due to pricing actions and reaching the levels seen during record pandemic season.
SG&A deleverage as a result of higher fixed costs and other costs such as wage expenses that are sticky amidst a decline in sales. Adj. EBITDA remained resilient at 12.4%, marginally improving by 10 bps YoY with TTM Adj. EBITDA remaining at 9.2%, above the pandemic average. This comes at a time when retailers are hesitant to stock up on toys as they try to clear an existing surplus that began piling up in 2022.
Balance sheet remains stronger than ever with the company becoming completely debt free prepaying the entire debt which was at a higher cost with cash balance of over $32 mn. This will provide them a significant agility and flexibility in capital allocation and take on any additional debt at favorable terms and for strategic purposes. Inventory position also improved significantly with the inventory levels declining over 50% YoY and 20% QoQ demonstrating continued improvements in the inventory turns while improving gross margins.
Valuation
JAKK trades at a dirt cheap valuation of 4.8x Fwd 1 Year earnings. While other player such as Hasbro ( HAS ) and Mattel ( MAT ) are much larger, better capitalized and strong network characteristics, we believe investors do not give enough credit to JAKK for its resilient turnaround performance amongst a weak environment. We initiate with a buy and assign a target price of $24 (at 6x 1Year Forward P/E)
Seeking Alpha assigns a favourable Valuation Grade of 'A+' highlighting the valuation comfort compared to its peers.
Risks to Rating
1) Any change in the consumer spending as a result of ongoing macro uncertainties and looming recession could put significant pressure
2) JAKK's business model is heavily reliant on its licenses, IP and partnerships with providers such as Nintendo, Disney and other and any failure to renew the partnerships would put a serious dent on the business model
3) While relatively insulated, JAKK is still reliant on the movies to create the buzz and drive up the collectible sales to an extent as demonstrated with the robust growth in Mario and Nintendo classic toy line as a result of the Super Mario Bros release
Conclusion
We believe the toys industry is not completely out of woods and there may be some short term pain after a record breaking season amidst the pandemic. However, we do think JAKK is undervalued relative to its performance and its reliance on evergreen brands, debt-free flexible balance sheet and strong IP licensing partnerships with a whole host of providers puts them in a sweet spot. We initiate with a Buy with a target price of $24.
For further details see:
JAKKS Pacific: Resilient Yet Undervalued