We are downgrading our rating on JAKKS Pacific Inc. (JAKK), which designs and markets a broad range of toys and consumer products, to Neutral from Outperform based on a host of factors. These include a decline in revenues in the second quarter, loss of the WWE consumer license, labor issues and container shortages in Asia as well as tough comparison in the second half of 2010.
Second Quarter Flashback
JAKKS Pacific reported its adjusted second quarter earnings of 17 cents per share, beating the Zacks Consensus Estimate of 5 cents. The company had incurred a loss of 3 cents per share in the year-ago quarter. On a GAAP basis, the company earned 11 cents a share. While the company experienced a decline in net sales, the results were aided by cost cuts, restructuring activities and strong demand for some of its products. The company’s revenues decreased 15.2% year over year to $123.3 million.
The company reaffirmed its guidance of $1.10 to $1.20 earnings per share and net sales of $660.0 million to $670.0 million for fiscal 2010.
Downgraded to Neutral
We believe JAKKS Pacific has emerged as not only a top five U.S. player in toys and leisure products, but also as a more diversified consumer products company, following a string of acquisitions over the past several years. Its long-term growth potential with new product launches, possible acquisitions, improved earnings driven by cost-saving measures and resolution of lawsuits would hold promises for investors. Besides, the company sits on ample cash balance. We consider JAKKS Pacific’s financial condition as a positive as it could be used to pursue further acquisition and share repurchase.
Although we believe JAKKS Pacific is well positioned to improve its fundamentals with decent long-term sales growth prospects. However, underperformance in key brands such as Hannah Montana and Pokemon as well as the loss of World Wrestling Entertainment Inc. (WWE) consumer license to Mattel Inc. (MAT) on January 1, 2010, will continue to remain drags on the company’s sales growth and lead to tough comparison in the second half of 2010. The company also eliminated its stationary and kite product lines, as they were no longer profitable.
Management remains concerned about production and shipment in the second half of 2010, mainly due to labor issues and possible container shortages, which have resulted in shipping delays and increased costs for many manufacturers doing business in Asia.
Moreover, JAKKS Pacific will likely face foreign currency headwinds. The vast majority of the world’s toys are produced in China. Moreover, the company purchases most of its inventory from companies in China, and, therefore, is subject to the risk that such suppliers will be unable to provide inventory at competitive prices. Hence, any unfavorable change in its currency or economic downturn will adversely affect the top and bottom line. The reliance upon acquisitions also carries additional risk into the equation and brings lower visibility in the company’s organic prospects. Hence, we downgrade the stock from Outperform to Neutral.