There Is Little Hope for This Toy Company

Amal is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

JAKKS Pacific (NASDAQ: JAKK) has been in a steep decline over the past month or so after posting catastrophic quarterly results. The company's revenue took a body blow, and when management said that the business would be facing turbulent times and not be able to achieve its targets, things got worse.

Woeful performance

JAKKS' second-quarter report revealed a major decline in revenue. The net loss for the second quarter was $46.9 million, a far cry from the $214,000 profit that the company had posted last year. Net sales came in at $106.2 million, a steep drop of 27% from the year-ago period. In addition, the company suspended its dividend and announced a major restructuring initiative that would result in huge cuts in jobs and lease space.

Stephen Berman, president and CEO of JAKKS, was disappointed that the company did not meet its second-quarter target and will not be able to achieve its full-year 2013 forecast. He said a variety of factors, like poor performance of several properties, including Monsuno and the Winx Club, and aggressive markdowns of its retail products in order to clear shelves for the back-to-school season, hurt the company. He also believes that the decline in sales reflects the continuing change in playing patterns of children of all ages.

Trouble in the future 

As children move to a digital platform to play games, JAKKS is finding it tough to sell its conventional toys. So it has also decided to go digital, and is slated to launch DreamPlay interactive toys soon along with items licensed from Disney and then move onto other franchises. But it remains to be seen if this initiative will actually help the company to regain lost ground or if it will be another failed experiment.

But JAKKS has lost a few important licenses to competing firms, and this is what might haunt the company in the future. It lost the license to make Pokemon products last year. And keep in mind that JAKKS' latest products, as mentioned earlier, Monsuno action toys and Winx Club dolls, are finding it difficult to sell and losing shelf space due to a transition to digital-play behavior.

So it did not come as a shock when management stated that they are going to miss estimates this year by a wide margin. The company is now expecting full- year sales of $620 million and the loss for the year is expected to come in at $2.56 a share. This is a significant reduction from the earlier forecast of $694 million to $700 million in revenue and a profit of $0.63 to $0.68 a share.

It is evident that JAKKS is facing trouble in its business, and I don't think that there will be a turnaround soon. Lack of interest in new products and a shift to digital play ,along with some tough competition, is doing the company a lot of harm. 

Competitors make it difficult

JAKKS is competing with giant companies like Mattel (NASDAQ: MAT) and Hasbro (NASDAQ: HAS), which have huge market capitalizations of $14 billion and $6 billion, respectively. Mattel has more than 120 brands covering a wide number of age groups. Brands like Fisher Price, Barbie dolls, Monster High dolls, Hot Wheels and Matchbox toys, WWE toys and early 1980’s video-game systems give it huge diversity.

To add to this diversity, Mattel is also looking to pen some strategic partnerships, like one with Disney. Mattel is looking to catch onto the success of Disney movies, such as Planes, which is set to be released this week. Mattel will also look forward to Disney's release later this year of Frozen, which should provide another good push as it is about a princess and might help faltering Barbie sales, which declined 12% in the previous quarter. Lower Barbie sales were offset by sales of Other Girls brand that rose 23%. 

Mattel looks like a good investment, as the stock is trading at a similar valuation to Hasbro with a trailing P/E of 19. The company's dividend also yields a solid 3.4% and analysts are projecting annual earnings growth of 9% over the next five years. If Mattel's partnership with Disney clicks, then there could be more upside in the future.

Hasbro also has more than 150 products and brands like Angry Birds, Captain America, Transformers, Star Trek, Spider-Man, Playskool, Monopoly, etc. So it is crystal clear that JAKKS is a small fish in the ocean, contending with big brands to survive and perform.

Linchpin

What is very interesting is that all are trying to profit from Disney. Hasbro recently expanded its tie-up with Disney to extend game and toy merchandise rights for Marvel characters until 2020 globally. Hasbro also has the rights to the Star Wars franchise. The relationship between the two companies is strong, and given Hasbro's wide range of products and famous characters, I doubt that JAKKS will be able to put up a fight.

Hasbro also looks like a good investment with a trailing P/E of 19 and a juicy dividend yield of 3.5%. I think that Hasbro is an even better investment as it has access to Disney's famous franchises such as Marvel characters and Star Wars, not to mention the hugely popular Transformers.

But analysts are not expecting solid growth here with the earnings growth estimate at 7.7% annually over the next five years. However, Hasbro can do better since it is involved with better known names and has a strong portfolio of products.

Bottom line

The mix of rapidly declining sales and rising costs mean that JAKKS' financial performance could decline further. Now, management is aware that the situation is worsening and has decided to do something about it -- a restructuring. The company is reducing headcount, leased space and overhead expenses. It has seen sales fall for four straight years and the future is bleak. I'm not sure if the initiatives will result in any meaningful improvements in the future because of tough competition and growing favor towards digital-playing methods.

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Amal Singh has no position in any stocks mentioned. The Motley Fool recommends Hasbro and Mattel. The Motley Fool owns shares of Hasbro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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