Toys 'R' Us May Be More Fun Next Year

With a blah holiday season ending a dismal 2001, investors may be better off waiting till 2002 and the full effects of remodeling blitz

By Nanette Byrnes

Here comes the winter solstice, yet it was a balmy 53 degrees Fahrenheit in New York City recently. Farther north in Boston, it was an unseasonably warm 42 degrees. The chances of a white Christmas are quickly melting, and with them the hope that this would be a halfway decent holiday selling season. For Toys 'R' Us (TOY ), which like all toy sellers relies disproportionately on December for profits, this is not good news.

Warm weather means fewer shoppers, and combined with a slumping economy, it's dealing all retailers a blow. According to the Instinet Research Redbook Average, a survey of 9,000 stores, sales at shops open at least one year were down 0.9% in the first week of December, compared with the same week in 2000. Last year at this time, they were up 2.2% -- and 2000 wasn't exactly a barn-burner of a holiday-shopping season, either.


  As a result, Toys 'R' Us stock has been drifting down, along with the retail industry. Although it has done much better than the Standard & Poor's 500-stock index in 2001, rising 19.5% since Jan. 2 vs. a 12.5% decline for the index, the out-performance came in the first half of the year. Since hitting a high of $31 on May 21, shares have dropped steadily, tumbling 35%, to $20 on Dec. 13. Over the same period, the broader market declined 14.5%.

What's an investor to do? The best move may be to wait until the New Year to decide whether to add Toys 'R' Us shares to the shopping basket. Although the stock is well regarded on Wall Street, even that support has shown subtle erosion of late. According to Thompson Financial Network, seven out of nine analysts covering the stock rate it a buy, a solid vote of confidence. But three months ago, four analysts rated it a strong buy, while today, only one does.

Though revenue is expected to decline slightly in 2001, to $11.4 billion, and earnings per share (EPS) are projected to remain flat at 95 cents, next year's outlook is much better: A 41% jump in EPS, to $1.34, according to estimates by earnings tracking service I/B/E/S. Still, it wasn't just this year that early investors did best. Historically, you would generally have done better buying this stock in the first quarter than later in the year.


  Because Toys 'R' Us is in the midst of an attempted turnaround, perception is especially important. A rough Christmas could be tough to take. This is the second holiday season since CEO John Eyler took over with a new vision for the chain. When he stepped in, the company had suffered a series of earnings disappointments, management turmoil, and some very public missteps on the Web. Eyler's strategy was that the company, which had already ceded the title of No. 1 U.S. toy retailer to Wal-Mart, would have to become something more than a low-cost emporium.

The CEO insists that Toys 'R' Us can once again become a growth company by creating stores in which customers enjoy shopping. To achieve that, he has poured hundreds of millions of dollars into remodeling 433, or 60%, of the chain's U.S. shops, training staff about better customer service, and focusing his inventory on the most popular and most profitable toys. Early results of the remodeling have looked good.

At overhauled stores sales are up 7% compared with similar stores without the facelift. Exclusive toys, some of which carry very fat margins, should hit 20% of sales by the end of 2001, up from 5% in 1999. As the company continues to revamp stores and more shoppers visit those already renovated, Legg Mason analyst Sally H. Wallick expects positive momentum to build earnings. "People who have kids have friends who have kids. To the extent [that] people hear about this store, it's positive," says Wallick, who upgraded the stock to a buy on Nov. 6. "They hear something different is going on there."


  Similar word of mouth is spreading on Wall Street, says Jeffries & Co. analyst Donald I. Trott. When he upped his recommendation to accumulate last November, he says many investors were still skeptical. Now, Trott hears at least once a week from an investor who has been pleasantly surprised once inside one of the new stores.

"From a Peter Lynch point of view, a lot of these investors are finding personally that they're having a very different experience at the store," says Trott, referring to the famed money manager who strongly believed in experiencing firsthand a company's product or service before investing in its shares. Trott also expects the company's new flagship store in New York's Times Square to add to the trend.

Still, it's hard to see adding shares to your Christmas list when you can wait for a clearer view in the New Year. By then, we'll know how retailers weathered the mild December and a dreary economy.

Byrnes is an associate editor for BusinessWeek in New York

Edited by Beth Belton

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE