Its toy business breaks down into four segments:
1) Traditional toys
2) Craft, Activity and Writing Products
3) Seasonal/Outdoor Products
4) Pet Products
Of these four, traditional toys is by far the biggest, representing over 86% of its Total Net Sales. It's also in a joint venture to produce video games featuring the World Wrestling Entertainment and its wrestlers.
The traditional toy industry is mature, very competitive, and stable. Toys are a consumer product so as long as JAKKS Pacific's toys are not extremely expensive, which they are not, they will still sell in the economic down times. According to the Toy Industry Association, the total traditional toy industry was $22.4 billion in 2004, $22.2 billion in 2005, and $22.3 billion in 2006. So, there is no growth. The total video games market has been growing though, and that is the opportunity that lies ahead of JAKKS Pacific. According to the Toy Industry Association, the total video games industry was $9.9 billion in 2004, $10.5 billion in 2005, and $12.5 billion in 2006.
JAKK is selling for a trailing twelve months price/earnings ratio of 10.31. It has over $192 million of cash and debt only of $98 million. It's trading at a forward price/earnings ratio of 10.14 for fiscal year 2008. Its main competitors, Hasbro Inc. (HAS) and Mattel Inc. (MAT), are selling at price/earnings ratios of 21.8 and 19.0 respectively. But unlike JAKK, they do pay a dividend of 2.3% for Mattel and 2.0% for Hasbro Inc. Here is the comparison between JAKKS Pacific and its two biggest competitors, Mattel Inc. and Hasbro Inc:
click to enlarge
What also jumps out in the comparison is that its P/E is half of what its bigger competitors P/E is. It is not the best run company in the toy industry, as the ROE compared to Hasbro and Mattel indicates, but it does not seem like it deserves the extremely low valuation it's receiving. Unfortunately, this has been the average valuation it has traded for in the past 5 years. Part of the reason for such a discrepancy in price/earnings ratio is because Hasbro and Mattel both pay a healthy dividend of at least 2%, while JAKKS Pacific does not pay a dividend.
It has been a solid performer in the past few years in the toy industry. Its revenue growth rate excluding acquisitions almost matched Mattel's of 3.7%. It has a great variety of products. Its 2005 acquisition of Pet Pal Corp. was a great extension to its line of toy products because it has allowed it to use its core competency of developing and marketing toy products and extend it to another product line.
Its cash flow from operating activities has been in a downward slope since 2004, from over $131 million in 2004 to almost $64 million in 2006 while earnings have been growing steady from $1.49 per diluted share in 2004 to $2.30 per diluted share in 2006. That is a major red flag. It seems like its earnings are of low quality. The competition it faces is fierce, and it does not seem like this will ease up in the near future due to the consolidation going on in the industry.
I decided to include both the 1 year and the 3 year view to show the longer term trading range:
JAKK is really close to its high of the year. The three daily moving averages align consecutively with the 20DMA above the 50DMA, and the 50DMA which is above the 200DMA. The daily moving averages are showing that JAKK is in a bullish trend. There is a troubling sign though, it just broke below its 20DMA on high volume. RSI is showing neutral and MACD is showing a slightly overbought condition. It is currently trading right at its 50DMA.
click to enlarge
On the weekly graph you can see that the stock has been in a trading range for the past 3 years, mostly it has been trading between $15 and $26 a share. Currently it is trading in the top end of its range.
click to enlarge
From the two graphs, it does not seem like this is the right place to open a position.
JAKKS Pacific looks significantly undervalued compared to its peers Hasbro and Mattel. The question is, does JAKK deserve the higher valuation its competitors have? While JAKK on average has traded for a P/E ratio for 10 in the past 5 years, Hasbro and Mattel have had an average valuation in the upper teens. Using a rough valuation, taking out the dividend effect on the P/E ratio of mature, slow growing companies like Mattel and Hasbro, the valuation does not look as great as before.
It seems like JAKKS Pacific does deserve a higher valuation, but not high enough to merit an investment. I am not sold on JAKKS Pacific at these prices, but if it does come back to recent long term support to around $16 a share, I would definitely be interested in initiating a long position as long as the story does not change. There just does not seem to be a significant margin of safety for me to be bullish on JAKK at these prices.
Disclosure: I don't have a position in JAKK.