MarketScience expects a blowout 4Q2012
Target stock price $15 to $20 (PE 12x to 15X) based on 2012 EPS estimate
The market is not giving LeapFrog the respect it deserves for performance.
MarketScience forecasts LeapFrog's EPS at $1.00 per share for 4Q2012 vs. $0.49 for 4Q2011. The $1.00 EPS forecast for 4Q2012 is a sequential increase from $0.60 EPS in 3Q2011. For the full year FYE December 2012, MarketScience forecasts EPS of $1.35 per share as compared to $0.75 to $0.81 as forecast by LeapFrog on November 5, 2012 earnings call (prior to the selling season). EPS was $0.30 cents per share in FYE December 2011.
In 2011 the LeapPad1 was one of the nation's hot selling toys for children ages 3 to 8. In 2012, the LeapPad2 was also one of the top selling toys for children ages 3 to 8. The LeapPad2 has a selling price of $100. LeapPad is designed for children and the company sells online content as well as play cartridges for $25 per cartridge. The company's toy sales are highly seasonal in the 4th quarter of each year.
LeapFrog's U.S. sales account for 75% of total company sales. About 65% of LeapFrog's total sales are from Target, Walmart, and Toys 'R Us.
MarketScience has tracked 420 Target stores in the top major cities in the U.S. for the green model LeapPad2 inventory (from December through January).
By December 21, 2012, 88% of the 420 tracked Target stores were out of the green LeapPad2. A check on January 13, 2013, showed the inventory outage at the 420 stores was 6.7%, with limited availability at 16% of the stores. A check on January 28, 2013 showed the inventory outage at those 420 stores was 14.5% with limited availability at 17.8% of the stores.
MarketScience visited a Target and Walmart store on January 16, 2013. Both stores had no inventory of LeaPad2. The local Toy 'R Us had only one LeapPad2 in inventory and the store manager was surprised that even one LeapPad2 was on the shelf. The store manager reported that they have not been getting many LeapPads in lately; and commented that they many this holiday season. The manager also reported that they had not really received much inventory in the most recent few weeks and he was not sure when more would arrive at the store. MarketScience visited another local Target and they had 5 LeapPad2 and the another nearby Walmart was out of stock. The Walmart stocking person ran the hand held scanner to see when more LeapPads would be shipping but the system (which normally reports this information) did not give the information. All of the stores checked with out of LeapPad 1 and Leapster inventory.
LeapFrog's inventories increased from $70.3 million at September 30, 2011 to $115.1 million at September 30, 2012. On the 3Q2012 earnings conference call, LeapFrog management issued conservative guidance for 4Q2012 because most of the sales results had yet to occur as of the date of the call. The business is highly seasonal and sales from Thanksgiving through Christmas are significant. Management also stated that they were worried that some of the sales in 3Q2012 could have taken away from 4Q2012 demand. On the earnings call, management stated they were in a good position with plenty of inventory. After the call, the stock price decreased and the shares short increased to about 18% of the stock float. It appears that the shorts have bet over concern of the risk of the company not selling the heavy inventory and the risk that the future competitive environment would be more difficult, with more tablet competition and lower prices in the future.
Inventory is very short in the channel. LeapFrog had this same issue in 4Q2011 and flew in extra inventory by aircraft (at extra cost) to meet 4Q2011. This left 1Q2012 short of inventory (a seasonally slow quarter). It is also likely that LeapFrog shipped in as much inventory as possible via aircraft in 4Q2012. LeapFrog had $45 million more in inventory in 3Q2012 as compared to 3Q2011. MarketScience believes the gross margin on the LeapPad's are at least 20% and it appears that LeapFrog had minimal product discounting in 4Q2012. MarketScience believes the sell through of the $45 million of inventory should increase revenue by at least $60 million over 4Q2011. Sales in 4Q2011 were $210 million. MarketScience projects 4Q2012 revenue of $270 million vs. the company's 4Q2012 revenue forecast of $198 million to $213 million.
Based on the above store inventory checks at Target, Walmart, and Toys 'R Us, MarketScience believes the LeapFrog also had strong sell through on the LeapPad software cartridges that carry gross profit margins in excess of 50%. Channel checks have shown very low inventory of LeapPad software cartridges at Target, Walmart, and Toys 'R Us. The strong sell through of software cartridges should bode well for the March 2013 quarter that is seasonally slow. Many of the software cartridges are purchased after December month end (after presents are unwrapped)
MarketScience believes LeapFrog has a brand, a niche, and an ecosystem of content. Some investors are concerned that LeapPad may be out of future growth headroom and will will confront more competition in the future. MarketScience believes that LeapPad has a niche market and is not competing against the Kindle, iPad, Nook, and other Android tablets. Those devices are for olders who do not need controlled experiences. Parents are interested in protecting and controlling the experiences of young children on tablet devices. LeapFrog is well positioned to offer that experience. The other competitors that many are concerned with in the tablet space offer a wide-open, wild-west approach to content download. LeapFrog has strong content partners for children entertainment and learning and is focused on further developing those content relationships. Parents desire the best learning and educational experiences for their children. This also makes LeapFrog an attractive acquisition target in the toy sector.
LeapFrog has established distribution channel partners in toy centers at Target, Toys 'R Us, and Walmart. This nicke market canot be easily be penetrated by competitors because of the scarcity of shelf space at the major retail stores selling toys.
A few analysts covering the industry are anticipating a sell-off of the stock after the 4Q earnings report based on the reason that this has happened in prior quarters after good results were announced but then the LeapFrog management gave conservative outlook. MarketScience does not subscribe to the sell-off theory based on past experience. The stock has sold off in the most recent days on the fear generated by some of the analyst comments.