The toy giant is discounting heavily, its business model is strained, and it's weighed down with $6 billion in debt
Times are tough for every toy seller, but this holiday season could prove particularly hard on Toys 'R' Us. The $14 billion chain, which was taken private three years ago, is heading into Christmas with $6 billion of debt, growing pressure from Wal-Mart (WMT), and a business model that leaves some analysts scratching their heads. "Its key value to consumers was a much broader selection, particularly of more expensive toys," says Dartmouth professor M. Eric Johnson. That doesn't exactly fit with the times, never mind an era where people gain a wide range of choice with a click of the mouse.
While Chief Executive Gerald L. Storch has made big changes at his 1,500-plus stores, the question is whether they will be enough to weather the storm. He has introduced electronics such as Apple (AAPL) iPods, spruced up the Web site, and combined Babies 'R' Us and Toys 'R' Us outlets into single locations to lift traffic and save costs. Just as business was picking up, with 6.4% sales growth in the second quarter, the Wayne (N.J.) retailer found itself in a recession. Consider that toy-only retailers such as FAO Schwarz and KB Toys went bankrupt after the last downturn. (Both have since emerged from bankruptcy.) And a November survey from research firm TNS Retail Forward found only 17% of U.S. shoppers plan to buy from toy stores this season, vs. 22% last year.
Storch, for one, says: "We don't believe [the recession] is necessarily as bad as people are saying." He is determined to woo customers by advertising some of the biggest sales in company history. Equity analyst Gerrick Johnson of Bank of Montreal Capital Markets (BMO) wonders if that could backfire. He recently visited a New York area store and says nearly every shopper was loading up on discounts, ignoring the full-price toys that actually produce a profit. Retail consultant Howard Davidowitz adds that "when you load a company up with debt in this environment, you are in a particularly precarious position."
Storch notes that the bulk of the debt isn't due until 2010. And, he adds, the bankruptcy of others may help him build market share. "There will be very few retailers who emerge unscathed this holiday season," he says. The question is who will bounce back.