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Christmas is coming but this time, the mood surrounding retailers and toy companies isn't as bright. According to IHS Global Insight, retail sales in the period between Thanksgiving and Christmas will only grow incrementally at 3% over last year. This general sentiment resonates with retailers like Macy's (NYSE:M) and Best Buy (NYSE:BBY), who have recently provided guidance for the coming quarter.

In its latest round of quarterly earnings releases, LeapFrog (NYSE:LF) provided a weak guidance for the coming quarter and for the full year, based on similar concerns over a challenging retail environment this Christmas.

I already own some shares in LeapFrog at an average of USD8.50 a share, and this smells like a wonderful opportunity to add to my position. Here's why:

1. LeapFrog is a great brand

I have asked several friends who are parents and most would know what LeapFrog is and represents. LeapFrog products are educational (parents love that in a toy) and made to last! Beyond this, most would remark that the products are pricey, which to me simply means that parents are willing to buy a LeapFrog product in spite of the high prices. All this points to a building of a defensible moat, which is LeapFrog is a great brand, and a good company to own.

2. LeapFrog has good, relevant products

LeapFrog's LeapReader and LeapPad range of products are wonderful platforms to help keep LeapFrog relevant as an "edutainment" provider. Content is purchased to be used together with the LeapReader and LeapPad products and this keeps a parent loyal to LeapFrog's products once they have started their children out from a young age.

Here's an example. I went to the store to get a LeapReader Junior (12-36 mo. toddlers) for a friend's child who was celebrating her second birthday. I was advised by the helpful shop assistant to instead purchase a LeapReader instead (normally bought for preschoolers between 3-5 years old) because I was told the child can keep using the LeapReader all the way as she grows from a toddler to a pre-schooler.

I was amazed. Typically a toy is bought for a specific age group and the child outgrows his/her toy pretty fast. Not with LeapFrog products as the depth of content allows parents to continue using LeapFrog's products from as young as 12 months to as old as 5 years.

Note: LeapFrog also sells products catered to other age groups, up to 9 years old.

I did a search on the internet just to check on reviews of the product and came up with the following set of results:

Partnerships with Disney (NYSE:DIS) on LeapFrog's contents make very good sense because of the ability to extend the content library and add good quality and recognizable brands to a mix of in-house content.

3. LeapFrog is inexpensive and has cash

The trailing 12 months PE is misleading as it shows a PE of only 6.90 as of November 26, 2013. The 2012 financial results include earnings skewed by non-recurring tax related items and to investors who unknowingly add this into their evaluation of the company's year-on-year performance, LeapFrog would be earning less from operations in 2013 as compared to a year ago.

For the third quarter, sales was up 1% for the USA and 14% for LeapFrog's international segment. On a normalized basis, earnings for third quarter 2013 was $0.38 per share compared to $0.32 per share last year. This represents a 18.75% increase in earnings.

The third quarter management discussion can be found here for those interested in understanding the details.

Management guided a full year earnings estimate of between $0.36 to $0.46. At today's (November 26, 2013) current share price of $8.25, this represents a best case PE of 18x which is fair if we compare this to Mattel (NASDAQ:MAT) at 19x and Hasbro (NASDAQ:HAS) at 24.3x.

Further, given that fourth quarter is traditionally a stronger quarter for retailers, I am pretty confident of an earnings beat. I looked back at the 2012 fourth quarter management discussion transcript and caught on to what management had presented. In spite of a "tough global economy", US business grew by 24% and international business grew by 38%. This shows that at least from past experience, management has what it takes to steer through tough situations.

Interestingly also, fourth quarter 2012 sales was $245 million up from $193 million in the third quarter of 2012. This seems more normal for a toy company heading into Christmas to perform better in Q4 compared to Q3.

I am convinced that earnings should at least be equal in Q4 compared to Q3 of 2013. If it is, we should expect to see full year earnings at about $0.65 (Q1 and Q2 Losses Per Share was $0.04 and $0.05 respectively). This is a PE of 13x which is more reasonable. Also, LeapFrog has about $180 million in cash and no debt.

If I assign a 15.23x PE (which is the forward PE for Mattel and Hasbro has a forward PE of 16.34x), I derive a target price of $9.90. This represents a 20% potential upside.

In conclusion, I am long LeapFrog and will continue adding to my portfolio on dips in the share price.

Source: LeapFrog Is Top On My Christmas Wishlist