2018: A Year of Change

2018: A YEAR OF CHANGE

The Toy Industry Moves Forward Without Toys “R” Us

by SEAN MCGOWAN, managing director, Liolios Group

AS THE TOY INDUSTRY GOES THROUGH fall previews, it’s hard to overstate how much changed in just one year. Let’s review the impact of Toys “R” Us’ departure, and discuss some of the other factors that will affect the industry over the next 18 months.

At this time last year, the industry was reeling from the fresh news that Toys “R” Us (TRU) filed for bankruptcy protection. In early September, the story broke that TRU hired lawyers to explore a bankruptcy filing, triggering fears that a filing was imminent. These fears were realized within weeks, setting off a stampede among companies trying to secure critical vendor status to bolster their prospects for getting paid for 2017 sales and be able to secure good prospects for 2018 sales. Barely six months later, the chain’s liquidation was underway, effectively inflicting the most damage on the very companies that were deemed the most critical. These companies found themselves in the position of effectively being forced to make shipments on which they

increasingly doubted they would collect.

Now that the other shoe has fallen through the floor, everyone is forced to confront the new reality. Among the industry’s largest manufacturers, especially the publicly traded ones, there is a sense that perhaps the situation isn’t as bad as they feared. No one was happy about it, but assumptions were so dire that sales declines that were not as bad as expected were greeted with a cheer on Wall Street. Spin Master actually grew sales in the first half, and Funko didn’t even mention TRU in its second quarter earnings conference call.

For smaller companies, the impact was pretty negative, and they don’t have the relief of being able to say, “Well, at least our stock price didn’t go down that much.” Some companies are scrambling to find capital, others have signaled their willingness to be

acquired, and others simply retrenched and hunkered down. We haven’t seen a massive wave of consolidation among toy makers, but sometimes it takes more than a few months to see the impact of these traumas.

The NPD Group reported that industry sales grew 7 percent during the first half, but it’s hard to parse out the impact of the TRU liquidation sales. Clearly, deeply discounted prices had some positive impact on total sales, and did not merely shift sales to TRU from other retailers. But did these sales come at the expense of sales that might otherwise have come later in the year? Has the industry, in effect, pre-sold holiday gifts? One could make the case that budget-conscious parents would be inclined to take advantage of big sales and squirrel away purchases in the spring to gift later in the year.

But we all know that kids often don’t

know what they want for their holiday gifts until right before they get it. Any parent knows there is a certain amount of wishful thinking that goes into buying holiday gifts too far in advance. And in a year that has seen tax cuts, rising consumer confidence, a booming stock market, rising home values, and modest inflation, it’s not inconceivable that parents simply bought more because they liked the prices, but will buy even more as the holidays approach.

What is also unclear is what exactly will be the outcome of the giant scramble to capture the sales lost by TRU. Last year, we saw retailers such as Kohl’s, JCPenney, and others grow or establish toy sections in their stores. This year, we can add Best Buy and Five Below to that list, as well as Party City, which recently opened approximately 50 Toy City pop-up stores (read more on page 34).

However, the big battles will be among the incumbent giants, Amazon, Target, and Walmart. Given the overall momentum in gaining toy share that the online leader enjoyed for years, Amazon is considered the favorite to be the biggest winner. Early in the summer, Amazon announced that it will publish a toy catalog for the first time, and published its Top 100 Holiday Toys list earlier than ever.

Amazon may be the favorite, but Walmart and Target are also doing their best to gain share. Target is expanding its toy space by an unspecified amount. Walmart was more open about its plan of attack, announcing in August that it would expand its toy shelf space by 30 percent, and increase the number of toys it will sell online by 40 percent. In addition, it designated Sept. 8 as National Play Day, and conducted 2,000 toy demonstrations around the country.

Who will win in all of this? It will likely be consumers and toy manufacturers. Regardless of who wins this battle, it is probably safe to assume that online toy sales will continue to grow as a percent of total sales. Toys have been sold online for more than 20 years, and such sales now comprise roughly 30 percent of total industry sales. There is no reason to think that this percentage can’t go higher, but there’s also no reason to think that brick-and-mortar sales will ever go the way of the dinosaur.

WHAT’S HOT FOR HOLIDAY 2018

Speaking of dinosaurs, let’s switch topics to the subject of what’s selling well. According to NPD, six of the top 20 fastest

selling toys in June were either dinosaur- or unicorn-themed. Against the backdrop of Jurassic World: Fallen Kingdom, it’s not surprising that dinosaurs are selling well. I’m not sure what’s driving the unicorn craze, but do we ever need a reason to imagine a world with unicorns?

Sales of toys tied to box office hits were pretty robust so far this year, and the outlook for the next 15 months or so is outstanding. The number of toyetic films slated for release between this fall and the end of next year is staggering. Characters from the Marvel and DC Comics universes will be on full display, and we will see multiple Disney live-action reboots, a LEGO sequel, a Transformers offshoot, Godzilla, Frozen 2, Star Wars Episode IX, and many others.

Manufacturers have to be careful not to dwell too much on how good next year looks. There is still much work to be done this year, which will see the first holiday season without TRU in the U.S. in more than 60 years. In addition, a great movie slate doesn’t mean everyone will win. As we have seen in the past, sometimes a glut of movies like this can have the effect of overwhelming the consumer to the point where any single property might under-perform, but in the aggregate, it’s likely a very good set up for total industry sales next year.

I will conclude by touching on two wonky warnings from the world of finance. First, the strength of the U.S. dollar this year is obviously a reflection of the great state of the U.S. economy, and that economic strength will likely serve the toy industry well. But the strong dollar will make it harder on U.S. companies relying on sales in those markets with currencies that weakened against the dollar. Net, net, it’s probably a good thing, but we expect to hear a bit of news over the coming months about how sales could have been higher if the dollar had not been so strong.

Second, uncertainties over trade battles— and, specifically, tariffs—have so far not had all that much impact on the toy industry. Toys aren’t on the list of products our president deemed to be so vital to national security that they need to be protected, but that may

just be because there are so few American jobs to protect. But the indirect impact of tariffs could have some negative impact if the result is higher prices on other products, or a diminishment of the strength of the economy. Trade wars are like real wars in that there is often collateral damage and unforeseen effects, even for the “winners.” And should tariffs on Chinese imports spread to toys, there is clearly nowhere enough production capacity to allow manufacturing to move quickly out of China. The factors that affect toy sales aren’t unique to toys, but that may be little consolation if the industry finds itself hampered by the effects of a trade war. »

Sean McGowan is a managing director on the consumer team of the Liolios Group, which provides capital market navigation and advisory services. He has been closely following the toy industry for 30 years, analyzing product trends, cost changes, marketing practices, and other aspects of how products and companies succeed (or don’t). He also follows digital gaming, sporting goods, and juvenile products. In addition, he is on the Board of Advisors of the Toy Industry Foundation.