• It's Here!

    Etf Pro

    Get the big financial market moves right, bullish or bearish with Hedgeye’s ETF Pro.

With the holidays on the horizon, it’s hard to ignore one of the most important gifts of all.  Toys.  Every year approximately 43% of the domestic toy industry’s $21-22 billion in sales occur in the 4th quarter.  Historically, the discounters including Wal-Mart and Target flex their square footage in the toy category to take advantage of the seasonal surge.  Toys R Us also enters the discussion as the sole category killer left in the competitive set.   At this point, TRU is estimated to be the number three player domestically, with annual market share of 16% a point or two behind TGT.  Wal-Mart dominates with a low 30% share.  Furthermore, it’s no secret that the company makes its entire yearly profit in the fourth quarter- a legacy of a fixed cost infrastructure that can only be leveraged during the highest volume quarter.   For most of us who have invested in Toys R Us in the past, we know that the company rarely exceeds expectations with so much pressure put on such a truncated but overly important selling season.  With an impending IPO on the horizon, keeping close tabs on TRU this year will be a clear indicator of what to expect in the future.

It’s no secret that toys are used as a traffic driver as well as a loss leader (at least for the discounters) during the holiday selling season.  With that said Holiday 2010 is shaping up to be one of the most competitive for the category in years.  Interestingly this has little to do with Wal-Mart’s obsession with price rollbacks or Target’s  “half-off” toy sale which began this past weekend.  It also has little to do with Sears’ efforts to put seasonal toy shops in its stores.  The biggest wrinkle in the no-growth toy business comes from Toys R Us and its plans to open 600 pop-up stores for the holiday season.  This represents a massive increase from the 90 temporary locations opened in holiday 2009.  As of now, the majority of the stores are open and ready to leverage TRU’s infrastructure at a very low incremental cost.  In fact, pop-up shops (a.k.a vacant stores with leases measured in months, not years) represent one of the most unique opportunities for TRU in years. 

TRU is looking capture the natural traffic flow that flocks to malls and outlet centers for holiday shopping by locating their pop-ups in these highly trafficked areas.  Stores will be stocked with smaller (who wants to carry a tricycle through a mall?), popular, and high margin SKU’s as the strategy aims to eliminate the need for consumers to make a trip to their local strip mall in search of this year’s Zhu Zhu pets.  The concept makes a ton of sense.  The exact  impact of such an initiative however, is unknown and remains a wildcard for the discounters.  No matter how the results ultimately shake out for TRU, it’s hard to ignore such a dramatic increase in the number of doors peddling toys this year vs. last.  In fact, TRU’s 600 pop-ups overshadow its permanent store base comprised of 483 units. 

Below we attempt to quantify the amount of business that TRU management expects to garner from this strategy.  While this alone is unlikely to wreak havoc on TGT or WMT, it is hard to ignore the fact that toy-driven traffic will be impacted in some way for the discounters.  We look at the impact of the incremental TRU square footage and potential sales from a few different perspectives. 

First we take a look at the potential amount of sales TRU could garner if 100% of the pop-ups were generating sales per foot in-line with the company’s historical 4Q average.  Management recently stated it expects productivity to be on par with that of its core business.  In reality this could be conservative given productivity in malls and outlets is generally higher than off-mall properties, but we’ll consider this a base case for illustrative purposes.

Toys R Popping Up Everywhere - pop up sq ft

Next we take a look at what these incremental sales would represent as a % of TRU, TGT, and WMT’s respective toy business over the 4Q.  In other words, if 100 % of these incremental sales had to come from somewhere (assuming the category is flat and this is a zero sum game), how would it impact each respective business?

Toys R Popping Up Everywhere - retail impact 100

Finally, we make an assumption that the impact of the pop-up shops negatively impacts each retailer’s core business at a level commensurate with the market share that each holds in the category over the holiday season.  Keep in mind that share numbers are different than the annual share numbers given that TRU experiences the largest seasonality vs. the discounters. 

Toys R Popping Up Everywhere - retailer share impact

While there is no sure way to know what the impact of the pop-ups will be on the discount channel, it’s pretty hard to ignore the fact that traffic may in some way be negatively impacted.  This comes at an especially important time for Wal-Mart given management’s renewed confidence in generating a positive same-store sales result for 4Q.  Is the impact of Toys R Us alone going to cause WMT to miss?  Probably not.  However the fact that TRU has the potential to generate an incremental $100-$400 million in revenue from its pop-up strategy is definitely worth watching. Something has to give and in a category with so much share centered on three retailers it may not be easy for any one of them to escape without impact (including TRU cannibalization). If anything, we’ll now be better prepared for the roadshow which is likely to follow the outsized growth TRU expects generate from the pop-up strategy.  

Eric Levine

Director