Funko Earnings Preview: Valuation vs. Momentum

FNKO stock - Funko Earnings Preview: Valuation vs. Momentum

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Red-hot toymaker Funko (NASDAQ:FNKO) is set to report second-quarter earnings after the bell on Thursday, August 9, and I think the numbers will be pretty good. FNKO stock should be able to rally on those numbers considering the recent momentum in the stock, as well as the fact that the company has multiple growth catalysts yet to materialize in the back-half of 2018.

But, valuation and big expectations are two risks here. FNKO stock trades at 22x next year’s earnings estimates. That isn’t that big of a multiple, but is a premium relative to peer toymaker Hasbro (NASDAQ:HAS). Also, FNKO stock has jumped from under $10 to nearly $20 since the last earnings report. That means big expectations for this quarter are already priced into the stock. Thus, even really good numbers could disappoint super bullish investors.

All together, there is little doubt that Funko’s Q2 numbers will be really good. But, there is some doubt that FNKO stock will be able to rally on those numbers. I think the stock can head higher after the report, but it is far from a sure thing.

Longer term, this stock does look good here and now. This a rapidly growing and different toy company that is ramping from a small base, implying lots of big growth years ahead. If Funko can capitalize on that long-term growth trajectory, then FNKO stock should head higher.

Here’s a deeper look.

Funko’s Quarter Was Likely Very Good

In case you haven’t heard, Funko is the coolest toymaker out there right now.

The company specializes on making unique looking pop-culture toys and collectibles. This style of toy has been mega popular recently, and the company’s results speak for themselves.

Last quarter, Funko reported a double beat quarter with 38.5% revenue growth, 200-plus basis points of gross margin expansion, and 100%-plus international sales growth. Two quarters ago, Funk reported a double beat quarter with 28% revenue growth, nearly 200 basis points of gross margin expansion, and 100%-plus international sales growth.

There is reason to believe this quarter will feature more of the same explosive growth.

Funko’s Pokemon toy is selling out everywhere, and the company has inked licensing deals to make toys for mega-popular Fortnite and Avengers: Infinity War. Beyond that, Funko even jumped into the cereal game, a lateral move which likely only broadened consumer awareness.

Indeed, if you look at a Google search interest chart for Funko, the trend couldn’t be prettier. The trend is up, up, and away, and search interest has only grown in exponential fashion this summer.

All together, then, it looks like Funko will report very good Q2 numbers.

Beware of Funko Stock Rally

Anyone who follows the stock market knows that strong quarterly numbers don’t always lead to a huge jump in stock price.

That could be the case here with FNKO stock. The stock has essentially doubled since the last earnings report, and now commands a premium valuation relative to other toymakers. Thus, buy-side expectations are big, and Funko will need a huge beat in order to send FNKO stock higher.

Can Funko deliver that huge beat? Maybe. But it is far from a sure thing. Buyers here should be aware that near-term risks are high due to valuation and built-up expectations.

Funko Stock Can Head Higher Long-Term

The long-term growth narrative supporting FNKO stock is quite strong.

This is a trendy, unique toy company that is leveraging pop culture to always remain relevant. This strategy is sparking robust revenue growth from a small base. Revenues are expected to be just $600 million this year, versus nearly $5 billion in revenues at Hasbro.

Thus, if Funko continues to execute on its unique growth strategy, this company has a long growth runway ahead of it. Funko could grow revenues at a 15% clip over the next 5 years, and revenues would still just be $1 billion, only 20% of Hasbro’s revenues.

Due to this big top-line growth potential, I reasonably think that Funko can do about $1.50 in earnings per share in 5 years. A growth-average 20X forward multiple on that implies a four-year forward price target of $30, which is more than 50% above the current price tag.

Bottom Line on FNKO Stock

Q2 earnings will likely be very good. FNKO stock should rally after the print, but near-term risks are high due to valuation and super-charged expectations.

Longer term, this stock should head materially higher given its promising runway for multiple years of big growth ahead. I realistically see FNKO stock heading towards $30 in the next 3-5 years.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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