FUN - Company Analysis

Here is some quick analysis on why Funtastic is a good company and might be worthy of a purchase.
Company profile
Funtastic Limited (FUN) is leading childrens products distribution and marketing company. FUN has several divisions marketing toys, stationery, apparel, infant goods, DVDs and food products all aimed largely at the child market. FUN has acquired a range of licences to manufacture (mostly offshore) and distribute popular childrens products. FUNs range includes long life and short life brands and products.

Company Strategy
FUN has grown organically through an increased number of new licensing relationships with major trademark and brand owners in its six divisions, as well as through the acquisition of complementary distributors.

FUN is an increasingly dominant manager of childrens brands in Australia. It is also looking to license proprietary product offshore. An example is FUNs patented baby stroller. It is critical FUN continues to provide customers, include the large department store retailers, with a compelling value proposition to ensure they do not source directly from licensors. Cost efficiencies and bolt-on acquisitions should offset weakness in consumer spending according to comsec.

FUN reported NPAT up 36% to $21.6 for the year ended 31 December 2005. Revenues from ordinary activities were $348.2m, up 11% from the same period last year. Diluted EPS was 16.2 cents compared with 12.3 cents. Net operating cash flow was $27.8m up from $12m. The company declared a final dividend of 6.5 cents, making the full year dividend for 2005 10.5 cents fully franked compared with 8.5 cents.

Institutaional Ownership

Institutaionl ownership pushes a share price up or down significantly depending on the support. Looking at the breakdown of shareholders there is only 4 major shareholdings. These are UBS at 8.16%, NSR Toys at 7.03%, Westpac at 6.32% and AH Meydan at 6.25%.

This leaves a lot of shares being held by smaller investors. In fact the top 20 investors only hold 52.25% of the company. This gives ample room for funds to move in and purchase shares in the company. For instance there is no Commonwealth or Colonial, or Perpetual holdings in the top 20 shareholders. There is ANZ, National, UBS, Westpac, JP Morgan and a couple more smaller fund managers in the list. They may also want to acquire further shares in the future, and there shareholding is not large enough to be detrimental to the share price if they sold all of their holdings.

Charting the stock

Looking at the chart shows that the stock has been in a slight downtrend for the last year and may be going sideways the last few months. This shows solid support around $1.50 and could go higher if it breaks the current range.

Looking at volume you will otice volume spikes i this company usually signal a change in trend. There was a volume spike in December 2004 which signaled a big drop, a volume spike in September 05 to signal another significant drop and finally a volume spike in July 2006 which started a spike upwards. This latest volume spike may signal that the sideways movement is about to finish and might help the share climb out of its sideways movement. If it does we can expectthe share to move up to the $2.00 area.

Growth

Growth is a very important factor in share price movement and we need growth to make substanital gains. The following growth was achieved at the company in the lastest annual report (March 2006) :

• Net Sales up 11.1%
• EBIT up 36%
• EPS up 30.5%
• CashFlow up 131.7%
• Net Profit up 36%
• Free Cashflow up 160%
• Dividend paid up 23.5%
• Toy market share gre from 19% to 24%
• Publishing market share increased from 7.6% to 10.3%

The first thing to look at is where did this growth come from. This is explainable by delving a bit deeper into the numbers :

• The net profit margin was increased from 5.4% to 6.2% which shows they have increased efficiencies from either increased sales or cost cutting measures.
• The long term debt has doubled indicating they have acquired businesses (planet fun and Dorcy Erwin Pacific) which add to the overall revenue and profit for the company.
• The increased debt allows greater tax deducations which may offset some of the interest costs when compared to the profit the acquisiton is making for the company.
• They divested the electical product range which may have been a poor profit margin product range.
• The company attributes the growth to better trade terms due to market position with key vendors.
• There has been major focus on invetory management therefore reducing coss for storage, etc and increasing the net profit margin.
• They have focused on debt collection which can alwasys be a tricky area.

Future growth is as important as past growth. Furture growth for this company may come from the following areas:

• They own the Pirates of the Carriban Range and the second movie should spark interest in the product.
• They have storng brands such as TMNT, Bratz, Tamagotchi, Thomas the Tank Engine and Spider man. These are toys that will sell well due to the high recoginition of the products from movies and television shows.
• They have acquired licences for Socceroo childrens wear which should e a major product range with the world cup just completing. They have also gained other footwear and apparel licences which will increase their market share and therefore may offer better terms of trade with suppliers.
• They are positioning themselves as market leaders in the nusery range such as strollers. This is a god idea with the number of babies pe household rising in the last year. The baby bonus also gives families the money to spend on these items which are necessities in some cases.
• They are growing the confectionary range and there should be solid growth in this area for the next few years.
• They have a continued focus on working capital and operating cashflow which should allow the company to minimise costs and take advantage of key opportunities when they arise.
• FUN has targeted more acquisitions to increase their market share and provide future growth. FUN management have done a good job of finding the right acquisitions rather than any acquisition. They have been able to find opportunities which have allowed the company to grow and increase profits. This track record stands them in high regard for furture acquisitional growth.
• They are taking an opportunity to move some of their own products global which may be beneficial for the company. There are risks with this strategy though.

Profitability

Profitability looks at the area on how much money (profit) is the company generating relative to the money which is invested into it. This is a key area as we need to invest in companies that make money and produce a return for their shareholders.

Return on Equity is an industry standard to determine how well a company is performing and how well it is in creating wealth for its shareholders. The ROE for FUN has been outstanding. The past 7 years has shown ROE figures of 16% or higher . This shows the company is doing a good job of managing their capital.

There are 3 ways a company can boost its ROE figures and this needs to be investigated before the figures can be regarded as authenticate returns. The ways a company can boost their ROE figures are net margins, asset turnover and financial leverage.

Net margins for FUN are excellent for this type of business, and while it has a fair bit of debt shown by debt to equity ratio of 44% I think the companies management are on the correct path and should slowly reduce the debt over the next few years. They have used the debt to buy solid assets which will generate good earnings for the company. To see whether the debt has helped the shareholders gain money can be seen by the ROE being higher than the ROC which is is in this case for the last 3 years.

Free Cash Flow is another measure which can give some indications into how a business is prospering. Free Cash flow is very important as this is the excess money generated by the business which is available for shareholders ( or available for the company to reinvest and expand the business ). My preference is usually for the company to give dividends as I can probably better invest the money elsewhere. Looking at the financial report shows that FUN has been increasing their payout ration (up from 33% to 65%) and provides adequate dividends at 6.4% (on $1.74). Free Cashflow is determined by taking the cashflow and removing the capital expenditure.

2005 Free Cash Flow = Cashflow – Capex = 20.8 – 2.3 = 18.5.

This shows the company has a strong cashflow position. This was a highlight of the company report and I expect they will continue to genreate good rfee cashflow positions in the future. Deteriming if this is enough free cashflow can be tricky as a guide we should aim for 5% of the sales revenue. Free Cashflow as per Revenue = 18.5 / 347 = 5.3% which is right on our target of 5%.

We can also look at the net profit for the last few years. This shows the company has conistently lifted its net profit year after year. It has gone from 1 million to to 3 million to 9 million to 14 million to 16 million to 21 million. That is a steady increase that hopefully will continue in the future.

Financial Health

Financial health looks at the current snapshot of the company and how well a foundation it has created itself. A company needs a strong financial health to ensure it does not run into extra costs and other financial burdens which could arise in the future.

The first figure to examine is the debt to equity. In this case it is 44%. This is a bit high due to recent purchases but I believe the purchases were good acquisitions and should enhance the profitability of the company. This follows a track record of good acquisitions and shows management thinks carefully before purchasing brands, products, etc.

The second figure is times interest earned which is how many times the company could pay the interest on its debt. The figure for the company is 9.11 which is a good figure considering the ASX average is 5 and the sector average is 7. This means they make enough money to cover their interest payments by 9 times.

The current ratio is how quickly a company could sell off assets to pay off debt. A general rule is 1.5 and FUN currently has a current ratio of 2.78. This is good as it is higher than our benchmark. The quick ratio is very similar to above except it is a bit more meaningful as it removes inventories which may be sold at a price lower than they are worth. A ratio above 1.0 is a good figure and FUN is showing 1.53. You can see how inventories are a major part of this company as it lowered the current ration by more than a whole point. Still the company looks in good shape.

A last test is to ensure the company has more Assets than it does liabilities. In this case it has 214 million in total assets and 100 million in total liabilities. This means if something drastic happened all debts could be paid and 114 million is available for shareholders.

Risks

There are numerous risks to this company including :

• Cosumer spending will be down due to higher petrol prices and interest rate increases.
• They are competing agaisnt fierce competiton and brand recognition is important. Losing brands could severaly hurt the company. In fact an announcement last week shows they lost a supplier due to a takeover. This will have a 9 million decrease effect on turnover.
• They have a semi-large debt to equity ratio which they will need to reduce quickly in case of interest rate rises.
• They do not develop many products and just hold the licences to distribute to suppliers. They must keep their prices low and offer extra services otherwise sellers could get their products directly from the suppliers.
• The chairman retired and there is no guarntee the new chairman will be as effective managing the business.

Management

Management is one of the most important aspects to look at when deciding whether or not to buy a company. it is management that makes all of the important decisions which could make or break the investment.

The reitrement of the chairman puts some added risks to this purchase. While the new chairman is the founder of the company and should have good business sense it is always hard to guage the effectiveness of the new chairman until a few years has past. At this stage I believe the board as a whole should have the expereience to take the company futher in to the future.

Firstly the renumeration policy should be checked. While I think all directors are overpaid, it is worthwhile checking they are not excessively overpaid. The total cost of all directors is 2.5 million. The renumeration is broken into 3 parts, fixed salary, performance incentives and long term incentives. This at least puts some of the 2.5 million at risk and gives management a carrot to aim for. Overall 2.5 million is a bit excessive considering the Net profit was only 21 million. This is slightly more than 10% of the overall profit. It should be under 10% of net profit.

Managements direction for the future needs to be looked at to ensure they are not boosting numbers now which will ultimately decrease profits in the future. Looking at FUN they have focused on reducing costs which is a good thing. They are also selling off unaligned businesses (electronic business). This is also a good idea. I also like their direction of expanding the company by buying acquisitions which they have proven to be able to align with the company and make profitable very quickly.

Overall I like the direction management is taking the company. They seem to be open about issues within the company and the direction they intend to take They are quick to inform the company of likely losses of revenue but they have also positioned the business to be able to handle these types of risks.

Target Price and Sell Targets

The target buy and sell points will be different depending on different peoples analysis of the company. I do not subscribe to the Discounted value system and instead prefer some easier figures to tell me whether or not the company is at a good value.

Firstly I like a high dividend. Usually I would aim for 5% fully franked but there are always exceptions to the rule. In this case the dividend yeild is closer to 6.4% fully franked. I like a higher dividend to provide some buffer against a falling price. Based on the 5% rule I would stake a rough estimate of approx $2.36 ( 11.8c / 5%).

Secondly I like to see a PE ratio which is not too high. This differs between sectors. FUN is at 9.7 while the market sits at 15.70 and sector at 11.70. This shows that FUN has a low PE ratio compared to the average. I like PE ratios which are low as they provide a quick indication that the company is earning good money relative to their value. Something to be careful of though is that there might be a low PE because the price has dorpped based on thoughts that the future earnings might be smaller. Looking at FUN shows estimates are for an increase in EPS from 19.2 to 21.5. If the estimates are correct assuming the PE ratio remains steady we should see the company move from the current price to $2.08. If we assume earnings are going to reamin steady and FUN comes back to the sector average we should see it rise to $2.24 .
Technically I can see the share moving back to resistance around 1.80. It would need to break this level before it could start a nice uptrend.

Based on the price estimates of $2.36, $2.08 and $2.24 We would look for a buffer where we see value. Usually a 20% buffer is a good start and in this case I don't think we need to increase it dratatically as there is no major risks to the company. Using a 20% buffer puts the buy for each of the estimates at around $1.88, $1.66 and $1.79. This is a broad range of estimates on the value of the company. I like to take a figure somewhere between the lower two values and this would indicate a value somewhere around $1.66-$1.79.

Sell targets would be analaysed as the share releases new reports but initially we should stick to our lower estimated value of $2.08. At this price the share would be fully valued and any gain from there would be minimal. At that stage we should look for other shares unless this share is showing reasons for its solid performance.

Overall

The company looks to be undervalued and while the economy has high inflation from petrol it may be found that the profit stays in check. But parents have this uncanny ability to overspend on their kids ascan be seen every christmas. This will buffer FUN from any slowdown in the economy. Also the baby bonus will help buffer FUN from this likely slowdown.

Managment appears to know what they are doing and if they continue the good work the company could grow dramtically in the next boom cycle. There is ample growth for instutional support and they are in a strong financial position.

I believe this company is a good purchase anywhere up to $1.79.

Good Luck