It’s a tough time for makers of pop culture collectibles.
The stock of Funko is in a funk. After the company posted its third-quarter report on Nov. 4, shares fell 59% to a two-year low. By beating analysts’ estimates by $46 million, revenue rose 37% year over year to $365.6 million. Despite this, adjusted net income fell 28% to $15.1 million, or $0.28 per share, undershooting expectations by $0.22.
As well as disappointing investors, Funko’s outlook was also disappointing. 25%-29% growth in revenue is expected for the full year, and an adjusted EPS decline of 33%-40% is expected for the full year. Analysts had predicted a 29% rise in revenue and a 35% rise in earnings per share. Even though Funko’s sales are still on the rise, its steep profit declines are causing concern. Investing in this dip would be wise, or should you avoid it because it could be a falling knife?
So, Is It Special Edition?
Bobbleheads and vinyl figures based on pop culture franchises are Funko’s most popular products. 77% of the company’s third-quarter sales came from Core Collectibles, which include Soda, Vinyl Gold, and Popsies.
Loungefly, Funko’s subsidiary that sells licensed pop culture bags and fashion accessories, generated another 17% of revenue, while its other smaller brands generated 6%. During the past three quarters, these three core businesses performed well.
Compared to its 48% growth in the fourth quarter of 2021, Funko’s midpoint of its full-year guidance implies its revenue will decline 5% in the fourth quarter.
This slowdown was attributed to macroeconomic headwinds, supply chain problems that kept the company’s inventory levels high, and less demand from major retailers struggling with their own rising inventories. Consumers’ appetite for bobbleheads and other pop culture collectibles has probably been curtailed.
Funko’s revenue growth is slowing down, resulting in shrinking margins. A year ago, its gross margin was 100 basis points lower than in the third quarter, when it rose 230 basis points sequentially to 35%.
As a result, its operating EBITDA margin dropped 520 basis points year over year to 9.8% from 14.6% in 2021 and 10.2% in 2020. This would severely decline from the 14.6% adjusted EBITDA margin in 2021 and the 10.2% adjusted EBITDA margin in 2020 for the full year.
This compression is primarily attributed to supply chain challenges and increased freight costs, according to Funko. As inflation eats away at discretionary spending, the company is trying to offset that pressure by outsourcing production to lower-cost facilities in Asia. However, the latter approach could backfire if the company implements its first price hike in five years.
A key component of that turnaround strategy is Funko’s belief that demand for its flagship Pop products will not fade with time. As with Beanie Babies, its soft guidance for the holiday quarter suggests its figurines will eventually disappear.
Even Funko’s management doesn’t seem too confident about this strategy. In the conference call, CFO Jennifer Fall Jung acknowledged that the company may have to discount a small amount because of tight inventory across our retailers. This will be in the back half of the year. However, she still predicted that the price hikes would take effect “by mid-2023.” Those mixed messages suggest that even Funko isn’t quite sure where its gross margins will land in 2023 and beyond.
So, What Then?
Funko’s stock has a price-to-earnings ratio of 0.4 times and a sales ratio of 0.3 times for the next year. Although analysts’ expectations are pegged to the company’s latest earnings report, they will likely shrink afterward. For example, despite their larger size and slower consumer spending, Hasbro and Mattel trade at 11- and 10-times forward earnings.
If Funko’s growth rates stabilize, its stock could easily double from these levels. In the short term, it doesn’t seem like Funko will be able to regain momentum anytime soon. Revenue growth has slowed, margins have collapsed, and consumers are grappling with record inflation, making its prices more expensive. It is still possible for Funko to fall much further before potential suitors show up. It is possible that Hasbro, Mattel, or other toy companies will take over the business in the future.