In the wake of yesterday’s CNBC report of a potential Toys “R” Us finance restructuring—and buoyed by recently announced LEGO layoffs and weak summer box office performances—US toy stocks from the likes of Hasbro, Mattel and Spin Master have been in a state of flux. But according to BMO Capital Markets Toys & Leisure analyst Gerrick Johnson, the prospect of Toys “R” Us hiring a law firm to help restructure its roughly US$400 million of debt due in 2018 isn’t as dire as it may seem. Or, at least, it shouldn’t come as a complete surprise.
“This is not the first time this has come up. We expect the company will be able to restructure its debts and extend its maturities, as it has done in the past,” Johnson says. New Jersey-based Toys “R” Us has a total of US$5.2 billion due between 2018 and 2021. “The toy companies I talked to were caught by complete surprise yesterday. None have had concerns about getting paid or receivables. CNBC made things appear much more ominous.”
Of course, TRU’s financial position has been an uncertain one for more than a decade. Twelve years after venture capital firms KKR & Co., Bain Capital and Vornado Realty Trust took over the retailer in a US$6.6-billion leveraged buyout, the retailer, by many accounts, has charted unsteady waters. Former CEO Gerald Storch’s favored strategy of securing more exclusives, integrating Babies “R” Us and FAO Schwarz into regular TRU stores, and placing more emphasis on the development of private-label products, seemed to increase the retailer’s market share for a time, but the company’s private-label offerings were not enough to compete with heavyweight e-tailers like Amazon.
With its long-running transformation strategy in place under current CEO Dave Brandon, the global retailer, which saw its consolidated net sales fall by US$113 million to US$2.2 billion in Q1 2017, is looking to drive growth with a revamped US$100-million e-commerce push. The need is there, after TRU saw its net sales dip 2.2% to US$11.5 billion in fiscal 2016.
“I don’t think a bankruptcy is looming. From a longer-term perspective, should a TRU bankruptcy lead to a liquidation, the industry would lose an important global retail distribution point,” Johnson says. A TRU liquidation would undoubtedly be well-received by its competitors like Walmart, Target and Amazon. (The latter was a driving force behind TRU’s decision to bring its entire e-commerce business in-house in July 2015.) “Walmart wants what’s hot and what’s selling. But TRU’s selection is wide and deep, and offers opportunities to smaller companies. Walmart may be the biggest seller of toys in the US, but it doesn’t really sell outside of top brands,” Johnson adds.
Johnson says smaller, independent toy manufacturers would suffer the most should a TRU liquidation ever occur. “TRU is the only dedicated toy retailer out there of any scale. It is a global company and has the toy industry’s best interest at heart.”
And industry is certainly booming. A recent report from The NPD Group found that global toy sales were up 3% in the first half of 2017, and the market research firm estimates the industry will grow by approximately 4% for the full year. “The toy sector has been strong over the past three years. You think tech is killing it, but it’s actually helping. Parents are pushing back and encouraging kids to play with toys,” Johnson says.
But in order for TRU to maintain its role in the sector—and avoid future uncertainty—Johnson says the company needs to become more experiential. “It needs to become a place where people want to go to be entertained and also buy toys. The company is not offering a unique experience in 2017, and it needs to give people more of a reason to go to its stores,” Johnson says. “Roughly 30% of all toy sales are online, but it’s not 100%. Parents still go to stores, but you need to get the kids in, too. How do you do that? With clowns? Or giraffes? Just anything you can’t get on Amazon. ”
For now, Johnson and his BMO colleagues believe TRU will successfully restructure and that the 2017 holiday shopping season will experience little disruption. Considering TRU makes 40% of its annual sales in the six weeks before December 25, the time period is a crucial one for the retailer.