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We recently upgraded our recommendation on Jakks Pacific Inc. (JAKK - Analyst Report) from Underperform to Neutral. While we are concerned about the stock following a host of factors like decelerating margins, top- and bottom-line miss in the third quarter of 2012, unfavorable product mix and wage inflation in China, we believe that these negative factors have already been factored in the current stock price.

Jakks Pacific cut its fiscal guidance, prior to the third-quarter earnings, owing to a tough retail environment. We believe this is already priced in the current valuation.

We believe that the strong product launches, possible acquisitions, strategic partnerships, resolution of litigation and strong finances make Jakks Pacific well-positioned for long-term growth. Over time, JAKKS Pacific has not only emerged as one of the top five U.S. players in toys and leisure products, but also created an identity as a more diversified consumer products company.

Jakks Pacific has been taking initiatives to strengthen its international business. Monsuno, an animated series, is an important overseas property for the company. Based on the Monsuno television venture, the company developed a complete Monsuno toy line. Although, Monsuno’s performance in the U.S. failed to match expectations, its global acceptance was encouraging.

Management is all set to tap international opportunities with the Monsuno toy line in countries like U.K., Italy and Australia. Jakks Pacific also signed an exclusive agreement allowing the sector behemoth Mattel Inc. (MAT - Analyst Report) to distribute its Monsuno toys to the Eastern European territories, including Hungary, Czech Republic, Slovakia, and Poland beginning the spring of 2013.

From a financial standpoint, the company remains in good health. We believe that an abundance of cash in its balance sheet ($140.8 million in the third quarter of 2012, 19.1% of total assets) will allow the company to successfully execute additional acquisitions going forward.
 
Furthermore, the ongoing fourth quarter is seasonally stronger for the retailers due to the holiday season. Thus, we expect the company to do better business in this period by employing a tactical approach.

Among its holiday collections, Winx Club will play a pivotal role. Winx fall sales, across major accounts, were in line with management’s expectation. Based on the initial success, retailers enhanced their fall 2012 promotional support which in turn should help Jakks Pacific.

Consequently, given the pros and cons, we adopt a Neutral stance on the stock. Jakks Pacific also holds a Zacks #3 Rank that translates into a short-term ‘Hold’ rating.
 

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