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Inspired by investors such as John Neff, I believe in giving a chance to the underdog and finding value in unloved stocks. One such company is JAKKS Pacific (NASDAQ:JAKK). JAKK is an overshadowed and undervalued small-cap stock in the toy industry. The market is dominated by much higher valued companies - namely Hasbro (HAS), with a market cap of $12.214 billion, and Mattel (MAT), with a market cap of $8.703 billion. Coming in at a market cap of only $128.33 million, and with toy-line licensing rights to two of the biggest movies of 2022 (the "Super Mario Brothers" feature film and "Sonic The Hedgehog 2"), there is plenty of upside potential for this stock for the rest of the year. In fact, the stock has been given a Zacks Rank No. 2 Buy and upgraded to Outperform by BMO Capital. Accordingly, Zacks analysts have been revising their estimates upward for full-year EPS by +24.89%.
It's important to bring to light the efforts and actions taken by JAKK to compete with larger companies to succeed in a highly competitive market. In general, the first quarter in the toy industry is seen to be the least profitable due to high fixed costs and low shipments and sales in the business. The company's most recent earnings report shows that it has surpassed net-sales expectations with a top-line earnings growth of 44.2% YoY. On average, analysts have given this stock a price target of $18, showing more than 34% upside from today's price. It is set to continue this upward trend, piggybacking on soon-to-be-released blockbuster movie-linked toy lines. In terms of valuation, the P/E ratio of 4.28 is very low and well below its peers, the average P/E for the market is 18.12, making it appear to be very undervalued compared to its growth rate. Taking into consideration these factors, investors may be interested in taking a bullish position on the company.
JAKK was founded in 1995 and is an American multi-line, multi-brand toy company designing, manufacturing, marketing and distributing toys and related consumer products and services sold worldwide. As of Dec. 31, 2021, it has approximately 583 employees, of which roughly 40% of its total workforce are based outside of the U.S. It successfully collaborates on product development with high-grossing movie, television, entertainment and gaming companies. It is focused on generating growth by creating innovative products within known brands and licenses, increasing toys within product lines, incorporating innovation and technology to appeal to modern-day children, and developing its international product offering.
JAKK does this by seeking out and building long-term relationships with businesses that have long product histories and acquiring or licensing these well-recognized intellectual properties, trademarks, and/or brands. The company is divided into two segments: First, toys/consumer products, accounting for 91.93% of total sales in Q1 2022, and, second, costumes, which has grown by 145.9% in sales since 2021. In the U.S., JAKK has tremendous brand power in the ultra-competitive and rapidly changing toy industry. Examples of toys and consumer products vary from action figures based on licensed characters from Nintendo and Sonic The Hedgehog, costumes for Halloween and everyday costumes, including Disney's (DIS) "Frozen" and Black & Decker, and outdoor activity products including tents based on Fisher-Price designs.
The company has had a few challenging years, including the bankruptcy of 22-year longstanding business partner and customer Toys 'R' Us in 2017. It has implemented internal restructuring, adjusting to rapid consumer demand changes with the advancements of technology and addressing an increasing number of direct competitors - such as gaming and entertainment. Moreover, it has had to contend with the implications of the COVID-19 pandemic and its various lockdowns, not to mention the speeding up of online consumer activity. The company has fought back quarter after quarter and has just reported its highest Q1 net sales since 2008 in the Q1 2022 earnings report.
The Toys & Games Market is valued at $291.72 billion in 2021 and is anticipated to expand by 4.7% from 2022 to 2030, irrespective of an economic slowdown.
If we drill down into the toy industry, the U.S. is the world's largest toy market, followed by China, Japan and Western Europe. Total retail sales of toys, excluding video games, in the United States were approximately $28.6 billion in 2021. Although there are hundreds of smaller companies competing against JAKK in the toy market, HAS and MAT hold a dominant share of the market and are by far the largest players in the U.S. toy market.
Over the years, the industry has experienced significant changes regarding consumer trends, technological advancements, and competitors. As consumer preferences evolve, the toy industry's ability to predict and match consumer demands has been challenged by several factors. Most prominent is that of technological advancements, which have caused children to lose interest in toys at a younger age. The gaming industry exponentially increased competition and provides alternative interactive products and services to choose from. Company products have shorter life cycles, and there are evolving complex online interaction expectations by consumers. The traditional bricks-and-mortar store with a lifetime product is not sufficient anymore.
The competition in the toy industry is fierce. In many of JAKK's product lines it is in direct competition with the industry dominant companies MAT and HAS. These companies are larger, more established, have greater financial resources and benefit from immense economies of scale throughout their supply chain, sales and marketing activities. These factors, in addition to others, allow these competitors to market their products at lower prices and with better terms to their customers. There are also hundreds of smaller domestic and international manufacturers, importers and marketers that compete within the different product categories.
JAKK's competitive advantage within this industry is to benefit from high-profile brands at a low cost through its licensing strategies. The licensing agreements not only help reduce costs, they also broaden the audience reach and give credibility to licensors that JAKK will prioritize their brands rather than compete against them. This year has already seen JAKK benefit massively from its extensive toy line for Disney's "Encanto." I have equal if not higher expectations that it will benefit from its master licensing agreement with the "Super Mario Brothers" feature film and "Sonic The Hedgehog 2" toy lines.
Additionally, JAKK has full ownership of Disguise, the number one global licensing/costume play that is focused on the growing world of cosplay, among other popular costume occasions such as Halloween. As seen in the Q1 report, costume sales of 2022 more than doubled versus Q1 2021. Its largest customers are U.S.-based Walmart (WMT) and Target (TGT), which accounted for 26.9% and 28.4%, respectively, of its net sales in 2021. JAKK benefits by making company-specific toys for these larger customers.
Furthermore, the company is focused on increasing international sales efforts and expanding its global distribution channels. It currently sells its products primarily in Europe, Australia, Canada, Latin America and Asia. International sales accounted for 16.9% of net sales in Q1 2022. Noteworthy actions are a joint venture in China through Meigheng, which owns 5.5% of outstanding stock as of Dec. 31, 2021. There are new sales offices in Canada, Europe, and Mexico and distribution centers in the UK and Europe. Progress over the last year can be seen with Q1 2022 international sales increasing by 59.4% since Q1 2021. Since 2020 it has also started selling products either directly to retailers or via third-party distributors.
Another key strength has been investing in its online business activities. COVID-19 has pushed many companies, including JAKK, to connect with customers through digital means. Some examples of that include online retail, digital videos, 360-product images, web enhancements, banners, and advertising. These investments into digital innovation facilitate brand building and gain momentum from the gaming and entertainment market. Digital experiences and enhanced webpages positively influence the customer experience. Sales and logistics have adjusted to a continued shift to online services. There is also a multi-tier development program focusing on designing and developing products specific to retail channels.
One of the biggest red flags is the large amount of debt JAKK has collected over the years. It has a cash-to-debt ratio of 34.47%. The company has asset-based credit line loans with JPMorgan Chase and Benefit Street Partners that mature in May 2026 and June 2027, respectively. This could negatively impact other sources of capital and create future financing difficulties if it fails to meet the payment terms. JAKK would need to aim to improve liquidity, extend debt obligation duration, and/or decrease overall borrowing costs.
In addition, although licensing agreements are benefiting sales there are high costs to some of these licensing agreement structures. Royalties range from 1% to 23% of net sales, with minimum royalty guarantees and up-front royalty payments. There is also uncertainty around the renewal of licensing contracts and the acquisition of new licenses in a competitive landscape.
Also, in order to compete with larger companies most of JAKK's products are manufactured in over 70 different unaffiliated manufacturers in China and Hong Kong. The COVID-19 pandemic caused supply chain issues in terms of exporting products out of Asia to the U.S., Latin America, and Europe. These factors, in addition to the ongoing issues in Ukraine, have increased the cost of ocean freight and trucking. This is expected to continue into the next quarter. The international playfield has environmental and legal obligations that can be unpredictable and costly.
Lastly, sales and the success of toy lines are highly influenced by the activities of competitors. For example, that can be affected by the release of competitor products, advertising activities, delivery dates and the ease at which new companies can enter the market. Furthermore, licensing agreements can overlap and larger companies can provide similar products at more competitive prices. Sales are highly seasonal - 2021 saw 68.4% of net sales made in the third and fourth quarters.
We cannot ignore the risks involved when considering a smaller, lesser known, and lesser loved stock, especially if the company doesn't have enough money to meet its current debt obligations. I do hope to have brought to light that there are strong reasons to believe this company will have a successful year to come, and that there's upside in the near term for this stock. That's because of its growth potential based on sales guaranteed by two very large blockbuster movies, in addition to benefiting from an improved online presence and international growth strategies. As the company reaps the rewards of strategic partnerships and management continues to make strong and committed business decisions, investors might want to take a bullish position in JAKK.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.