by GERRICK JOHNSON, senior analyst, BMO Capital Markets
Though many folks in the toy industry know who I am, few know what I actually do. I am an equity research analyst for BMO Capital Markets and, in a nutshell, I make stock recommendations to institutional investors (mutual, hedge, and pension funds).
My area of expertise and stock coverage is in the toys, video games, and leisure industries. I simply call it “The Fun Space.” Analyzing the toy industry and the publicly traded companies in it, though, has been difficult due to the lack of in-person industry events for nearly two years. Having covered toys for 20 years, I have developed many great relationships, and it’s always nice to walk the floor of Toy Fair New York, the Toy Insider’s Sweet Suite (Editor’s note: Adventure Media & Events, parent company of the Toy Book, produces Sweet Suite), or Toy Fair Dallas and bump into friends and acquaintances, and be introduced to new ones. And, of course, I love seeing the toys! Not being able to speak to as many toy friends, nor to see as many toy lines, means I don’t have the insight I normally would have on innovation or trends. Instead, this analyst is spending more time looking at macro factors. As I write this, I fear I will be rehashing many of the same themes as others.
Clearly, the effects of the COVID-19 pandemic are still front and center. We know well that the toy demand surge was caused by parents wanting to keep their kids busy while they were home from school, camp, sports, and playdates. While that demand factor has dissipated owing to the “Great Reopening,” there are new factors helping to sustain demand. The reemergence of the in-person birthday party — replacing the horn honking drive-by — has probably had the biggest positive impact, especially during the off-season. We also see playdates and other gatherings reoccurring, and having that networking effect helps stimulate demand. I call it “The Playground Factor.”
Last year, I anticipated a strong holiday season as parents looked to provide their kids with a fantastic and bountiful holiday as a way to make up for the really crappy year they had to endure. The absence of in-person events meant that 2020 would be the best Christmas or Hanukkah ever!
“Clearly, the effects of the COVID-19 pandemic are still front and center.”
Parents’ shopping also got off to an early start, given the uncertainty around lockdowns and store openings. And many embraced online shopping, including those who may have been hesitant about it before.
This year, that holiday comparison will be difficult, especially with some parents perhaps feeling a bit guilty that they may have spoiled their kids a little too much over the last year and a half (as I look around my 5-year-old’s cluttered room).
This year, I expect shopping to get off to an early start again given the high level of uncertainty around the rise of the COVID-19 delta variant. I also expect early shopping to occur because parents are hearing about looming shortages of product owing to supply and distribution bottlenecks. Adults have already been experiencing these issues in other areas of life, whether it be the patio furniture on back order for the last eight months or empty shelves where basic household cleaning products should be. Early shopping always leads to more buying. There will always be new toys that catch parents’ eyes or new and unexpected gift requests. The ongoing pandemic and availability uncertainties could work in the toy industry’s favor, at least from a demand perspective.
I think, however, that the federal government’s fiscal stimulus will play the biggest role in terms of increasing demand. The child tax credit covers more than about 85% of families in the U.S. and is quite generous: $300 per child under age 6 and $250 per child ages 6-17, though the payment is gradually reduced over certain income levels. This augmented income, coming in each month for the remainder of the year, should have a significant stimulative effect on toy purchases. Families have their regular monthly payments, such as mortgage or rent, car payments, and utilities, then what’s left goes toward the weekly budget, which is basically food and gas. Whatever’s left over at that point generally goes toward the kids. This season, there should (hopefully) be a lot more left over for the kids.
While there is plenty of visibility into demand, the supply side, however, is more uncertain. I have spoken with many in the toy industry — as well as adjacent consumer products industries — who are quite concerned, not only about the cost of goods this season, but also about their ability to deliver them. I hear panic in the voices of some industry contacts. In my leisure coverage, dealers for boats, off-road vehicles, and motorhomes are experiencing inventory levels anywhere from 30-80% below normal levels. As they say, “you can’t sell what you don’t have,” and recent retail sales have been down sharply because of it. The publicly traded toy companies, however, seem much more confident that they will be able to service the demand they see, and do so in a cost-efficient and margin-accretive manner. Greater scale, better resource availability, a diversity of manufacturing geography, and strong relationships with retailers give them confidence.
Pricing is no doubt going up to offset some of the costs, and one prime example is that the retail price of Monopoly is 10% higher on Amazon this year versus last year. And it seems that with strong demand and constrained supply, promotions, markdowns, and allowances should be minimal. Still, I have been, and remain, concerned about public toy companies’ ability to achieve back-half targets owing to distribution bottlenecks. Shipping gets much more challenging as toys compete with holiday shipments of iPhones, apparel, and electronics. I have been closely following the work of our transportation analyst and the cost of freight — whether it be air, sea, or land — continues to go higher. Never lower. Always higher.
As for numbers, my estimate is that the U.S. toy industry, as reported by The NPD Group, will be down 8% for the back half and up 1% for the full year, on a year-over-year basis. This is based on NPD’s reporting of 16% growth last year and 19% growth for the first half of this year. Up 1% for the year would put the industry up 17% versus 2019. For the back half, even though I predict a decline of 8% versus 2020, it would put the period up 4% compared to 2019.
“I have been closely following the work of our transportation analyst and the cost of freight — whether it be air, sea, or land — continues to go higher. Never lower. Always higher.”
As for trends, I think toys that rely on collaborative play will benefit from kids being able to get together. Spin Master, for example, commented on strength in Bakugan for this reason during its second quarter earnings conference call. Role-play toys should benefit from playdates where playing house, cops and robbers, or tea party is, at least, more acceptable than it was last year.
Collectibles could continue to do well, too, as back-to-work seems to be pushed back and those still at home look to surround themselves with comfort and collections. The action category looks tough again, with no tentpole movies to drive hype. I just don’t see Black Widow, Shang-Chi and the Legend of the Ten Rings, or even Snake Eyes: G.I. Joe Origins creating much excitement in the aisle. I also anticipate board games underperforming, as most families are well-stocked at this point.
Finally, there is a rush to digitize kids’ play experiences. These products are high-margin and don’t rely on ocean transport from Asia. With remote learning, parents have grown more accustomed to, or accepting of, the learning potential of tablets or laptops.
Multiplayer video games have become an acceptable way for kids to connect and interact with their friends. Breaking into gaming can be difficult, though, particularly mobile as there are literally tens of thousands of games for parents and kids to wade through. Existing games have a first-mover advantage (Candy Crush has been a top-10 mobile game for six years). However, games based on strong underlying intellectual property can break through the clutter. And one thing that the toy industry does have going for it is a plethora of strong, known, and trusted brands.
This article was originally published in the October edition of the Toy Book. Click here to read the full issue!