Toy Recalls Make Investors Gun Shy

09/19/2007 12:00 am EST

Focus: STOCKS

Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, says recalls of popular Chinese-made toys has prompted investors to avoid the stocks—and perhaps miss opportunities.

It's a parent's worst nightmare: the Big Bird in the nursery is coated with lead paint.

It's an atmosphere that has investors worried that toy safety concerns will hurt sales during the holiday season, when these companies ring up more than a third of their annual sales.

As troubling as it is for parents, I think investors are worrying too much about the problem. Ultimately it's fixable. China will figure out how to make all of its toys lead-free.

All this makes stocks like Mattel (NYSE: MAT), RC2 (NASDAQ: RCRC), Hasbro (NYSE: HAS), Jakks Pacific (NASDAQ: JAKK), and Marvel Entertainment (NYSE: MVL) attractive contrarian investments over the next six months.

I calculate that since the August 1st D-Day for toy makers (when Mattel announced a recall), Mattel, Hasbro, RC2, Jakks Pacific, and Marvel Entertainment have lost 8.5% of their market capitalizations—or $1.5 billion—while the Standard & Poor’s 500 is down less than 1%.

But I think investors can profit by buying any of these stocks now, for the following reasons.

Companies are on the case. Mattel now says it is checking every production run in China. Hasbro has stepped up testing. Jakks says it has inspectors perform both random and scheduled inspections of suppliers. More rigorous inspection puts toy makers on the path to solving the problem—which means it blows over with time.

Survey research from Britt Beemer of America's Research Group, in Charleston, SC found that 75% of parents cannot name a toy company involved in the recalls, and only 11% of parents are concerned about the problem. "I don't see any real big issue," he told me last week.

It's also unlikely shoppers will [be able to avoid] any toys made in China. The reason: parents are going to see "Made in China" when they turn over virtually any toy box in the store aisles—because 80% of US toys come from that country. An "avoid China" strategy will mean no toys for the kids this holiday season, which is unlikely.

[Also], the toy makers look cheap. Mattel currently goes for 14.6x trailing earnings, near the low end of its historical range. Hasbro [also] trades at the low end of its range. Jakks Pacific goes for 9.7x trailing earnings, well below the industry average of 16.7x.

We are also entering the time of year when they normally do the best. They all tend to pick up in early October, says Phil Erlanger, who provides technical analysis at Erlanger.com. He says the seasonal strength for RC2 and Marvel Entertainment typically lasts through the end of the year. Seasonal strength for Mattel, Hasbro, and Jakks tends to peak in early December.

(On Tuesday all the stocks traded well below their 52-week highs—Editor.)

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