Funko Stock: Full Steam Ahead (NASDAQ:FNKO)

There have been very few exceptions to the small-cap world being absolutely crushed this year by the risk-off mentality that the markets have adopted. Funko (NASDAQ:FNKO) is one of those few exceptions. This little-known collectibles and toymaker, best known for its Pop! figurines that line the toy shelves of major retailers in the U.S., has been quietly outperforming all year and achieving massive growth rates while also navigating past supply chain challenges and rising freight costs.

Year to date, shares of Funko have jumped 10%, dramatically outperforming the ~20% loss in the S&P 500 and significantly beating other small-cap peers. In my view, given the recent string of wins that Funko has accomplished, this streak is just getting started.

I remain bullish on Funko and encourage investors to ride the upward wave. The company has some recent developments as well that continue to support the bull case for the stock.

The first: in early May, an investor consortium led by the Chernin Group (and in which the participants include former Disney CEO Bob Iger) purchased 25% of Funko’s stock at $21 per share (roughly where the stock is trading today). Not only is this a major vote of confidence and validation of Funko’s future and its growth trajectory, but the deal also included a strategic tie-up with eBay (EBAY) that made eBay the preferred secondary resale channel for Funko products, while also leaving the door open for exclusive product releases in the near future.

In other corporate development news, Funko in June also acquired a company called Mondo. Mondo specializes in collectibles including toys, books, posters, apparel, and vinyl records and also works across various popular franchises like Marvel and Star Wars, making it a nice fit into Funko’s burgeoning universe.

And as a reminder to investors who are newer to this name, here are all the long-term reasons to be bullish on Funko:

• Unparalleled ability to source and monetize the best content. From Fortnite to Pokemon to Marvel and other brands, Funko’s ability to nab the best content is unrivaled. No single brand dominates Funko’s revenue, so it’s well-diversified to be the beneficiary of a general rise in entertainment and pop culture.
• International growth push. Though primarily a U.S. company now, Funko is driving strong growth overseas, especially in Europe, where in the most recent quarter, Funko managed to achieve ~60% y/y revenue growth.
• NFTs. Last year, Funko acquired a company called TokenWave, which enabled it to finally get its skin in the NFT craze that kicked up amid the pandemic. Funko notes that its first few token offerings have “sold out in minutes,” potentially opening the door to an entirely new and fast-growing revenue stream going forward.
• Healthy profitability. Surprisingly enough for a small-cap company, Funko is profitable from both an adjusted EBITDA basis as well as GAAP earnings. In my view, investors’ hesitation around small-cap stocks generally stems from their favoring growth over profitability, but in Funko’s case, it can brag about having both.

In spite of all these strengths and very bullish recent news, Funko still remains quite cheap. At current share prices near $21, Funko trades at a market cap of $1.05 billion. After we net off the $33.1 million of cash and $168.9 million of debt on Funko’s most recent balance sheet, the company’s resulting enterprise value is $1.19 billion.

Meanwhile, for the current fiscal year, Funko has guided to $1.275-$1.325 billion of revenue (+24-29% y/y growth), as well as 14.6% adjusted EBITDA margins at the midpoint of that revenue base.

This puts Funko’s expected 2022 adjusted EBITDA at $189.8 million, and its valuation at just 6.3x EV/FY22 adjusted EBITDA – so it’s no wonder major investors are acquiring a chunk of Funko at its current bargain-basement prices.

Stay long here – there’s a lot more room for further appreciation in Funko shares.

Q1 recap

Let’s now go through Funko’s latest Q1 results in greater detail. The Q1 earnings summary is shown below:

Funko’s revenue grew at a blazing 63% y/y pace to $308.3 million, in the quarter, beating Wall Street’s expectations of $272.0 million (+44% y/y) by a massive nineteen-point margin. Revenue also accelerated substantially relative to 49% y/y growth in Q4.

What is interesting is that Funko’s main source of growth is no longer through acquiring additional licenses. The company had 763 “active properties” at the end of Q1, which is flat to last year. However, net sales per active property grew 63% y/y to $404,000.

As you can see in the chart below, the top-selling property per quarter continues changing, reflecting the diversity of Funko’s fan base. And these top ten properties, which continue rotating the top sales spots, represent no more than 31% of Funko’s overall sales.

Another major positive in the quarter: the company managed to maintain better-than-expected gross margins thanks to successful price increases. Gross margin in Q1 was 35%, 610bps lower than the year-ago quarter, but this was offset by both price increases and the stronger-than-expected revenue growth, which produced immense operating expense leverage.

Remarking on the company’s demand strength and successful channel pricing boosts on the Q1 earnings call, CEO Andrew Perlmutter noted as follows:

We delivered strong sales growth in our direct-to-consumer channels, led by increased traffic on our websites, enhancements across our e-commerce site grow year-over-year improvements, an important efficiency metrics including conversion and bounce rates.

Our channel wide price increases were effective and helping to offset ongoing supply chain cost pressure while we maintain strong unit demand. And together with our newest NFT partner Warner Bros. we released Scooby-Doo, which was our largest Digital Pop! NFT drop to date surpassed only this morning by our second Warner Bros. collection DC Comics. These strong results can be attributed to three primary factors, exceptional consumer demand, a portfolio comprised of compelling industry leading brands and focused execution by the entire team.

Our excellent first quarter performance gives us even greater confidence in the business going forward. As a result, we are raising our full-year revenue and earning targets.”

Funko also still grew adjusted EBITDA by 22% y/y to $36.3 million in the quarter, though adjusted EBITDA margin peeled back 290bps to 11.8%, driven by gross margin pressures.

Key takeaways

Funko is rapidly firing on all cylinders. Even though freight and gross margin pressures are weighing on the company (just like on every other consumer-products maker), Funko’s tremendous growth rates are still enabling the company to expand its bottom line. The Chernin Group’s recent 25% buyout of Funko shares is yet another vote of confidence in Funko’s direction. Though not a broadly known stock, Funko is an excellent small-cap name to add for portfolio diversification.