JAKKS Pacific: Partnering For Growth In The Economic Toy-Train (NASDAQ:JAKK)

JAKKS Pacific, the focus of my first SeekingAlpha article in May 2022, has rewarded investors with an impressive 92.16% return since then. Witnessing this underdog triumph against industry giants like Hasbro (HAS) and Mattel (MAT) has been gratifying. Starting with a market cap of $128.33 million, the company has grown to $276.61 million today. Despite 2023’s industry challenges and the tough act of surpassing FY2022’s record, JAKK Pacific has beaten EPS expectations for the last three quarters, including the most recent Q3 2023 results. Looking forward to FY2024, strategic investments in the less developed European market, partnerships for the Sonic the Hedgehog 3 movie, The Simpsons licensing, and a multiyear deal with Authentic Brands Group promise robust growth potential. With a proactive approach driving visible growth drivers, I maintain my long-term bullish outlook on this agile company that has generated better returns over the last three years than its larger peers.

Company updates

JAKKS, a small yet dynamic player, thrives on partnerships with prominent entities in the film, gaming, and entertainment sectors. Large customers such as retail giants Target (TGT), Walmart (WMT) and Amazon (AMZN) bolster its market presence. Offering a mix of affordable and premium products, over 70% of their lineup is priced under $40 at retail, with a significant portion under $20. When I initially covered JAKKS Pacific, its growth was driven by key licensing rights to blockbuster films like the ‘Super Mario Brothers’ feature and ‘Sonic The Hedgehog 2.’ The company soared in 2022, setting high standards that seemed challenging to replicate. Year to date, in FY2023, we have seen lower net sales. However, the gross profit margin has improved through close collaboration with Asian manufacturing partners and substantial investments in new product development.

In Q3 2023, the company experienced notable progress driven by its operational strategies. This quarter stood out as the highest shipping period, accompanied by a significant improvement in the gross profit margin, which reached 32.5%. We can see the expected gross profit margin for 2023 stands at 34.5%.

The company segments its revenue into two categories: the established Toys/Consumer Products and the newer Costumes segment. While year-to-date revenue and gross profit for 2023 lag behind those of 2022, it’s worth noting that Q3 2023 exhibited higher gross profit compared to the same period in 2022.

Across various product categories, there were mixed performances with declines in some categories while others showed promising growth. Action Play and Collectibles soared impressively by 43% YoY in Q3 2023, almost doubling since 2021. Conversely, Dolls, Role-Play, and Dress-Up witnessed a 27% YoY dip for the quarter, still surpassing 2021 results. The Outdoor Seasonal business experienced a slight 2% YoY decline, with expectations for improvement driven by the introduction of new fall items. Notably, despite not yet impacting sales, the multiyear deal with Authentic Brands Group, known for brands like Forever21, is poised to boost outdoor seasonal sales in the future.

The company’s global expansion efforts are evident, particularly with a growing focus on Latin America through its Mexican office and an established presence in Europe, boasting an office and warehouse in Italy. Looking ahead to FY2024, strategic agreements are in place to support the release of Sonic Hedgehog 3 Paramount Pictures feature film in December 2024. This is anticipated to bring forth a diverse range of products, spanning from toys to costumes. Similarly, an extensive product line is in the works for The Simpsons franchise, showing a proactive approach to capture market opportunities.

Financial updates

Following a record-breaking financial year in FY2022, JAKKS faced a challenging start, with a 20% decline in the first half of the year. However, Q3 showcased a notable improvement, with only a 4% downturn, accompanied by robust sales of $309 million. Notably, the gross profit margin surged to 32.5%, marking a 4% YoY increase in year-to-date gross profit, reaching $186.9 million. In terms of operational metrics, the company displayed positive trends, evident in the increase in Adjusted EBITDA from $59.4 million to $67.1 million for Q3 2023. The Adjusted net income saw an increase YoY for the quarter by 16.2% to $50.1 million.

Furthermore we can see that TTM levered free cash flow is positive at $80.25 million. This allows the company to reinvest in the business, reward investors and pay off debts. If we look at the balance sheet the company ended Q3 with a cash balance of $96.4 million and has a low total debt of $25.7 million with a good liquidity if we see the current ratio of 1.48.

Valuation

When assessing JAKKS Pacific in comparison to industry leaders like Hasbro (HAS), Mattel (MAT), and Funko (FNKO), a notable undervaluation emerges, evident in its attractive price-to-earnings ratio of 5.17, nearly three times lower than its larger counterparts. Moreover, investors are currently paying less than a dollar for every dollar earned, with a low price-to-sales ratio of 0.38. Despite the company experiencing a reduction in its top-line performance throughout the year, it has shown improved earnings. Looking ahead, the significant growth drivers anticipated for 2024 instil considerable confidence, reinforcing my bullish outlook on this stock.

Risks

JAKKS Pacific operates within the consumer discretionary space, making it susceptible to shifts in the economic climate. With the recent slowdown in US retail, the company experienced a correlated decrease in sales. Notably, while JAKKS boasts diverse customer bases, its major clients contribute significantly to its revenue stream. The current trend of low single-digit year-to-date sales from its top three US retail accounts has directly impacted JAKKS’ performance. This dependency on a few key clients poses a risk to the company’s revenue stability and necessitates a strategic pivot towards diversification to mitigate potential downturns in specific client sectors.

Additionally, operating within a fiercely competitive industry, JAKKS faces formidable competition from larger companies boasting higher gross profit margins. However, JAKKS has showcased an upward trend in improving its margins over the past year. In a scenario where competitors engage in price competition, JAKKS might encounter challenges in further reducing prices without compromising its business viability.

Final thoughts

JAKKS Pacific, despite challenges in 2023, has shown resilience and strategic foresight. With upcoming movie tie-ins, a partnership with Authentic Brands, and strong Q3 operational performance, including plans for international expansions and increased sales in key areas, the company displays promising growth potential. Financially sound with improved margins and solid cash reserves, JAKKS is well-positioned. While economic sensitivity poses risks, its diversified customer approach and clear growth strategies make it a compelling long-term bullish opportunity in the toy industry.