For the past year, I have followed JAKKS Pacific, Inc. (NASDAQ: JAKK), the fascinating growth journey of a small-cap toy company in an industry led by giants like Hasbro (HAS) and Mattel (MAT). Everyone loves a good underdog story, and this year is proving ever more compelling for this underrated and seemingly still underrated title. Through licensing agreements with much larger companies, JAKK is showing that dynamite can come in small packages. The company has produced consistently strong performance in both revenue and net income over the past four quarters and has rewarded its shareholders with returns of 86.71% year-to-date.
As we begin the holiday season and JAKK continues its strategic licensing deals with Disney, Nintendo and Sega, demand is secure through Q1 2023 in the form of sought-after action figures and costumes for kids and adults looking to celebrate the Christmas season and expand their blockbuster movies and streaming experiences with characters from Sonic, Super Mario and Encanto. Although investors should be wary of high levels of leverage, rising supply chain costs and the impact of general market uncertainty on consumer buying behavior, JAKK appears to be in going to achieve a record year. With the stock price dropping 8% in the past month, it could be an exciting time for investors to take a bullish position in this stock.
JAKK has had back-to-back success with its strategic partnerships to produce toylines and costumes for massive hits, including Encanto and Sonic the Hedgehog last year. In the first quarter of 2023, Super Mario the Movie, another blockbuster that has already created a huge buzz on the Internet, will be released, and we can expect a similar success to what JAKK already delivered last year. Although JAKK is one of many companies creating products for these toy lines, it has a solid reputation and a presence in all the right places.
JAKK works with many offline and online retailers. However, Target (TGT) and Walmart (WMT) are among its biggest customers. Many of the costumes available from TGT and WMT are produced by Disguise, JAKK’s costume company. One of the critical growth factors has been its point of distribution. JAKK has increased shelf space and door visibility at many local and international retailers. There is also a wider range of products available and due to the full range, JAKK products are more visible in all stores. Merchants are also developing their online presence, making it easier for consumers to access offers.
Another growth factor has been the speed with which JAKK has responded to increased demand. Data and feed algorithms have been key in predicting recurring popular products. The company has also focused on its international growth, and we can already see some impressive numbers if you look at the increase over the past year.
Costumes are a small but growing part of the business that is sure to see an additional impact on business performance. This year, JAKK has already shipped 25% more customers than in 2021.
Third quarter 2022 financials and valuation
2022 has been an incredible year for JAKK, and the third quarter further confirms the performance. Year-to-date, JAKK has already topped 2021 net sales by 6.9% at $621.1 million. It saw its net sales for the third quarter increase 36% year-on-year to $323 million. Again, we can see the growing importance of the company’s suits business to its performance, generating 16.5% of total sales at $53.4 million. We saw a decline in gross margin, to 28.5%, although operating profit increased by 16.7% of net sales to $53.7 million.
The decline in margin is mainly due to transportation costs related to the supply chain. EBITDA increased 42.4% year over year to $59.4 million. JAKK has positive free cash flow this quarter. Total cash and cash equivalents were $76.6 million, nearly three times higher than the previous year. This upward trend is a positive sign that the company has the money to resume operations and reduce outstanding debts.
Debt has been something to be wary of when looking at the history of JAKKS and the outstanding debt to be paid. The company made an optional payment of $17.5 million for long-term loans in the third quarter. Year-to-date principal repayments total 29% of the balance at $29.0 million, or 29% of the remaining $69.5 million.
In my previous article, I compared JAKK to larger players in the market, and these comparisons clearly show that JAKK has plenty of room for growth and could be an attractive takeover target by any of the toy and entertainment companies. of several billion dollars. The company is valued well below its price target of $26.33 and its valuation ratios are well below those of the best companies in the industry. If we look at Seeking Alpha’s quantitative ratings over the past six months, we can see valuation, growth and profitability on an upward trend, and we have yet to reach the historically best performing quarter of the society.
Although JAKK is a micro-cap stock, it is not new to the market and has seen many ups and downs over the years in the ever-changing and competitive landscape of the toy industry. An investor who invested in the stock ten years ago would have seen the stock price drop by 84.66%. However, over the next six months, the company is on track to continue delivering strong numbers.
Second, we have seen that the gross profit margin has decreased. This can have a big impact on an industry where customers are price sensitive and there are plenty of big company alternatives in the market. These larger companies have more pricing flexibility due to economies of scale. However, JAKK seems to use data analytics to create highly sought-after products in a timely manner to compete in the market.
Finally, there is a lot of uncertainty in the market and toys should be considered essential goods. However, historically the toy industry has weathered economic downturns and JAKK’s prices are considered affordable, with over 50% of its products selling for less than $25.
JAKK is on course for a record year. If we compare it to its earnings, it has a strong cash flow and an exciting toy and costume pipeline driven by home streaming shows and blockbuster movies. With Christmas fast approaching and four quarters of solid performance behind them, there is much to celebrate for this small company taking on giants. Investors may want to take a bullish stance on this company at a price well below its major competitors.