Tuesday, March 27, 2018

Another Category Killer Gets Killed

You know who’s on the list: Circuit City, Borders, Linens N’ Things, Sports Authority, Comp USA, Child World, and on and on. This time the “category killer” getting killed is Toys R Us.

Toys R Us has been around since 1948, when Charles Lazarus opened a baby furniture store, originally known as Children’s Bargain Town. The Toys R Us banner made its debut in 1957 and became a public company in 1978. In 1983, offspring Kids R Us opened its first stores, penetrating the childrens apparel market. By the time Mr. Lazarus retired as CEO in 1994, the company had grown to over 1,000 stores in 17 countries.

In 1996 the Babies R Us brand evolved, adding another growth concept to its repertoire. However, following several years of strong expansion, the company started feeling the competitive effects of a growing list of mass merchant retailers, and more recently online retailers, which resulted in a never-ending erosion of market share.

To illustrate the stagnation in Toys R Us sales performance during the past decade: Domestic sales at Toys R Us were down 6.8% through Q3 in 2017 and if sales remained on the same trend through year end, the company will end the year with US sales of roughly $6.6 billion, which, besides toys, also includes apparel, furniture, and other baby-related categories. The company’s Fiscal 2007 sales were $6.0 billion, reflecting an estimated compound annual growth rate over the past decade of a mere 0.96%. Same store sales are expected to be down 4.4% for this year.

The Toy Association, the toy industry’s trade association, indicates that toys sales in the US approximated $27 billion in 2017. Walmart took the lead in toy sales in the US as far back as 1999 and has never looked back. Currently the formidable discounter captures about 30 percent of the US market, according to IBISWorld. Toys R Us holds an 18% share and the slimmest of margins over Target, which has an 17 percent cut of the toy business.  Kmart sales represent a small but not insignificant share estimated at about 3.4 percent. Small specialty shops and online catalogs claim the remaining business with Amazon the most notable, generating approximately 5 percent of total sales.

At the end of Q3 2017, Toys R Us operated just shy of 800 stores domestically (discounted for outlets stores and both permanent and temporary express stores, which range from only 3,000 to 7,000 square feet). Currently, 735 stores remain. These units include traditional toy stores, generally sized between 20,000 and 50,000 square feet; Babies R Us stores, ranging from 30,000 to 55,000 square feet; and side-by-side combo stores that can be 30,000 to 70,000 square feet. Barring a partial sale of the company - which reportedly remains an option that could potentially preserve 200 US stores - a complete liquidation would incrementally add approximately 30 million square feet of retail vacancy within the US.

The two questions that always come up when bankruptcies are announced are, “Who will absorb the sales?”  and “Who will fill the vacancies?” Often there are direct competitors who pick up a chunk of the business - in fact, Toys R Us itself was able to take advantage of the Child World closing years ago. Best Buy immediately came to the fore when Circuit City filed, Bed Bath & Beyond benefitted from Linens N’ Things demise, Barnes & Noble absorbed a considerable share of Borders business, and when Sports Authority closed, Dick’s was there to benefit. But this time it’s not so clear cut. Walmart is probably the frontrunner to pick up a share of the business and Target will likely gain significant sales as well. Amazon is obviously in a strong position to grab a lion’s share of the freed-up online business. But beyond these retailers, it may be the independent toy operators that stand to collectively benefit the most.

Regarding replacement tenants, we can point to Sports Authority to get an idea of how successful landlords might be. Approximately the same prototypical size as Toys R Us, only five of the 15 Sports Authority stores that operated in Eastern Massachusetts, Southern New Hampshire, and Greater Hartford have found replacements. Burlington, HomeGoods, Sierra Trading Post, Party City, and The Guitar Center have either committed to, or currently occupy, these units. Comparatively, there are 19 Toys R Us stores occupying approximately 764,000 square feet. Fortunately, 12 of these stores are isolated from vacant Sports Authority units and should not have to compete for the same prospects.

At the same time, candidates to fill these stores will be limited. Consequently, we can expect to see a significant impact on vacancy rates in all regions which may take some time to fully mitigate - and that’s only until the next category killer bites the dust.

Bob Sheehan, VP of Research
BSheehan@KeyPoint Partners.com

The KeyPoint Reports for 2018: coming soon!

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