2023-03-16 14:11:16 ET
Summary
- JAKKS Pacific, Inc.'s fiscal Q4 2022 ended up being a victim of its own success.
- JAKKS was stating all the way through the year that it was seeing unseasonal demand. But all investors heard was JAKKS saying ''demand'' for its products.
- The lessons we can take from JAKKS Pacific, Inc. stock.
Investment Thesis
Was JAKKS Pacific, Inc. ( JAKK ) over-earning in the early parts of fiscal 2022? Or was it the case that fiscal Q4 may have been just an unlucky and challenging quarter?
One way or another, the facts are that investors got too excited and hopeful headed for its fiscal Q4 results .
So, what now? Can the argument be made that against a substantially more restrictive macro environment, somehow JAKKS will be well-positioned to positively surprise investors?
As much as I want to cheer for the underdog , sadly, I'm no longer convinced that JAKKS can impress to the upside.
Therefore, I'm now neutral on this stock.
Fiscal Q4, Challenging Set of Results
JAKKS reported fiscal Q4 results that startled investors, leading its shares to fall approximately 20% post-earnings.
Recall, all the way through fiscal 2022, JAKKS had been masterfully executing. This lead many investors, myself included, to get positively enthused about its prospects.
But when its fiscal Q4 results came out, JAKKS simply didn't manage to live up to investors' expectations.
Therefore, as we look ahead, we are forced to ask the question, what's next?
The Perils of Unusual Seasonality
The graphic above highlights 3 problems.
Firstly, fiscal Q4 saw JAKKS' momentum peter out.
Secondly, and more pressing, investors are now thinking to themselves that JAKKS will be up against more challenging comparables this year than it was in the prior year. Simply put, a lot of investors will be thinking if there's any point to stick around in this stock?
Thirdly, consider this quote from management (emphasis added):
Our exceptional performance in 2022 in combination with our unusually heavy first half seasonality combined to generate over 86 million in operating cash flow in 2022.
Simply put, JAKKS is openly acknowledging that fiscal 2022 was unusually seasonal. If any investors in the name weren't fully aware of that consideration before, by now, they are.
Consequently, this means that investors will need to stick around here until the second half of fiscal 2023, for JAKKS seasonality to once again return to investors' favor.
But...the Stock is So Cheap!
Let me provide further context to my concerns facing this investment. We all know that JAKKS reported, roughly speaking, $76 million of free cash flow in fiscal 2022.
But when we dig further, we can see that fiscal Q4 2022 reported $8 million. And that's the crucial problem of investing in the toy industry. There's just so much competition. And you are being forced to constantly guess what consumers' top preferences will be over the next 12 months.
When things are going well, they end up going swimmingly well. But if consumers close up their pockets or seek out different merchandise, JAKKS is left holding on to that excess inventory. And this, naturally, means higher warehousing costs, which impacts its underlying profitability.
So, yes, paying just 2x trailing free cash flows is absurdly cheap. Even irrationally cheap . But when you see that Q4, which is typically one of its strongest, reported just $8 million of free cash flow, suddenly what appears to be priced at 2x free cash flow, becomes dramatically more expensive.
What Lessons Can We Learn Here?
I strongly believe that when a stock is going up, nobody is asking difficult questions about their investment. The stock is going up and you feel like a genius.
But when the stock goes down, then you are forced to ask serious questions of yourself.
For me, while I fully recognize that nobody is right on every stock, I will personally work harder to rethink whether my company is over-earning.
Indeed, if you look around at the whole market, that's precisely the problem most companies are now having. We went through a period where there was a massive amount of pull forward in demand, post-covid, and now as we are lapping the prior year, the results of many companies look lackluster.
The Bottom Line
JAKKS Pacific, Inc.'s ability to acquire profitable IP on new brands is far from guaranteed. And as much as JAKKS attempts to diversify its line-up, there's no question that a few brands drive its fortunes, or lack thereof, for that year.
And then, to add insult to injury, JAKKS Pacific, Inc. still has to plow through the ''more traditional second-half seasonality'' facing the business this year. Whatever you decide, good luck here.
For further details see:
JAKKS Pacific: Unusual Seasonality Was The Killer