Stocks & Markets September 29, 2010, 6:14PM EST

Air Hogs, Sing-a-ma-jigs May Bring Holiday Joy for Toymakers

Investors are betting that hit products and stepped-up efforts from retailers will boost sales of children's toys this holiday season

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(Updates with Sept. 30 Fisher-Price recall announcement in third paragraph.)

Investors are betting that toymakers, from the world's largest, Mattel (MAT), to niche players like Leapfrog Enterprises (LF), will fulfill their wishes for a successful holiday season—and erase the memory of a coal-filled 2009.

With the small-cap Russell 2000 Toys index up 43 percent so far in 2010, toy stock investors are increasingly optimistic that the industry can recover, despite the gloomy mood of U.S. consumers and two previous disappointing holiday seasons.

Mattel was dealt a setback on Sept. 30 when its Fisher-Price subsidiary announced the recall of almost 11 million toys, including tricycles, infant toys and high chairs, for safety concerns. Despite the news, Mattel shares rose 0.7 percent in early morning trading on Sept. 30.

The outlook for the toy industry is "looking extremely strong," says Stephen Berman, chief executive officer of Jakks Pacific (JAKK), one of five publicly traded toy companies in the U.S. "Last year was really a tough year not just for our industry but for all consumer product industries," he said in an interview with Businessweek.com.

Some Sales Improvement

In 2009, Jakks, which makes items like night-vision goggles and the Disney Princess & Me dolls, saw its sales drop 11 percent. U.S. toy manufacturing is dominated by Hasbro (HAS), which saw sales rise 1 percent last year, and Mattel, where sales fell 8.2 percent in 2009.

Analysts predict an improvement in some results during this year's holiday season. According to analysts surveyed by Bloomberg, Hasbro should see flat sales again this year, but sales at Mattel are estimated to rise 8.9 percent in 2010.

Investors are placing their bets on the industry. Since the start of 2010, Mattel shares are up 18 percent, and Hasbro shares are up 40 percent. Jakks shares have risen 48 percent in 2010. RC2 (RCRC), which makes collectibles, baby gear, and the Thomas & Friends railway sets, is up 38 percent this year, while shares of educational toymaker Leapfrog Enterprises have advanced 40 percent.

Their rise has accelerated in recent weeks, with all five U.S. toy stocks up more than 10 percent—and an average of 14.2 percent—in September alone.

Hot Toy List

Investors' renewed attention on toys is prompted by the end of summer and some good news from the industry, analysts say. On Sept. 21, Toys "R" Us (TOYS) released its annual "holiday hot toy" list.

Among 36 new toys, it featured singing stuffed animals in the form of Mattel's Sing-a-ma-jigs; a four-inch-long remote-controlled helicopter called the Air Hogs Pocket Copter from privately held Spin Master; and LeapFrog's Leapster Explorer, an electronic, handheld educational device.

"There is some great innovation in the toy industry," says Gerrick Johnson, an analyst at BMO Capital Markets. There may be some "pent-up supply" of new products held back in the gloomier 2008 and 2009, he says.

Also lifting spirits in the toymaking industry are Toys "R" Us's plans to open 600 temporary stores during the holiday season. By taking vacant space in U.S. malls for a few months, the retailer is boosting its number of U.S. Toys "R" U.S. outlets by 71 percent.

On Sept. 24, Reuters reported Sears Holdings Corp. (SHLD) was also expanding its toy offerings by opening 85 toy shops in its Sears stores.

The actions have "been perceived as a bullish bet on toys for the holidays," says Drew Crum, an analyst at Stifel Nicolaus (SF). "Interest has picked up."