Toy stocks pounded, cautious days ahead

By Brent Felgner -- Playthings, 1/16/2008 9:36:00 AM

NEW YORK—Toy industry stocks have shown weakness in the new year—showing an average decline of 14 percent as of last week, among five leading companies—and that weakness is accelerating, according to long-time industry analyst Sean McGowan, managing director at Needham and Co. Prices have dipped further since his comments.

Coming off an unusually weak holiday season in which retailers guarded inventories against skittish consumers—complicated further by continuing product recalls—McGowan said he had believed most of the weakness had earlier been priced into the stocks. In a research note last week from a conference presentation, McGowan said his overall investment stance remains cautious on most toy companies.

While noting that LF is trading at a low ($5.06 in midday trading on Tuesday, Jan. 15), McGowan calls the stock a strong buy and pegs as 12-month target at $11 per share. He said the company has ended the year with more than $100 million in cash and that the company continued to exude optimism for 2008. He said the stock has “considerable upside” over the next year and further upside over the next two years.

Among his comments on other large players in the group:

Mattel Gets Upgrade Jan. 16, 2008 — Stating that Mattel’s short-term challenges have been “more than adequately discounted,” toy industry analyst Sean McGowan on Wednesday raised his rating for the company from “hold” to “strong buy,” even as he lowered his earnings estimates for the company for the next three years. “We believe the current stock price more than adequately discounts a host of headwinds, including tightening consumer spending, rising costs and the hangover of last year’s product recalls,” he wrote in a morning research note. McGowan, who is managing director of equity research for Needham and Co., set a 12-month target price for the stock of $26 — about 15 times his ’09 earnings estimate. Mattel’s stock price has been hammered by investors, closing Tuesday at $16.65, just above its 52-week low of $16.42. McGowan reduced his 2007 EPS estimate to $1.42 from $1.47. The company will report its full-year results Jan. 31. He lowered estimates for ’08 and ’09 to reflect more conservative sales projections and the potential impact of a prolonged writers’ strike on Hollywood films and related toy sales.

• Mattel also hit a 52-week low at $16.75 in midday trading Tuesday. “The bigger they are, the harder they fall, I guess, and MAT is the biggest. The stock seems to have no bottom. I think it may be overdone at this point, but may get more overdone,” he wrote. McGowan said that while he recognizes Barbie sales have been weak, he doesn’t believe that the whole business is as weak as the stock price suggests. He sees potential for a post-EPS report rally and advises investors to “keep the powder dry and keep it close.” (McGowan upgraded Mattel early Wednesday from “hold” to “strong buy.” See accompanying article.)

• RCRC’s presentation indicated a weak fourth quarter and that improvement may not be coming for several more quarters, he said. The company faces “significant cost pressures” in 2008 as it tries to win back the trust of consumers—and apparently investors. The stock is trading at or near a four-year low.

• Jakks Pacific, while trading at the low end of a range, apparently had a reasonably good year in 2007, according to McGowan, and despite the bad behavior of its stock, is one of the two toy companies (the other being Hasbro) least likely to disappoint when results are released. It’s entering 2008 with more momentum because of Hannah Montana sales but McGowan noted the potential for serious “headline risk” related to a legal action and the future of its WWE licenses. The company is likely to make an acquisition in 2008, which could be a catalyst later in the year.

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