Santa Could Be Late This Year as Toymakers Face Supply Crunch

Toy sales had a surprisingly good year in 2020. Despite the headwinds facing the sales of many other retail products, toys were in high demand as kids were at home more often, increasing the need for at-home entertainment.

Stimulus checks and unemployment benefits also had a positive impact on toy sales, as many households would not have otherwise been able to afford extra purchases such as toys during a difficult economic situation.

A blowout year

According to data from The Toy Association, toy sales in the U.S. amounted to $32.61 billion in 2020, an increase of 16.7% compared to 2019. In 2019, toy sales had declined 3.5% from the previous year. The Toy Association further broke down the sales numbers into categories, with games, puzzles, outdoor and sports toys and building sets representing the biggest increases in 2020. The only category that declined year over year was action figures and accessories, which was down 3.2%.

However, UBS analysts have sounded the alarm that supply chain issues could affect the toy category just in time to impact stock levels during the holiday season. According to analysts led by Arpine Kocharyan:

“There is now increasing risk supply disruption could put a strain on toy inventory in the months leading up to the holiday season… Inventory in the channel is relatively clean, driven by overall healthy demand and supply constraints that have worsened.”

There could also be supply shortages in the months leading up to the holiday season as well. According to analysts, “We could start to see ‘supply holes’ as early as Sept/Oct ahead of holiday season.”

Normally, toy stocks represent attractive buys ahead of the holidays, as their sales for the year peak during the October to December period. However, could the opposite be true this year due to the combination of supply constraints and high valuations following their recent run-up?

The uneven recovery

Following successful vaccination efforts and the lifting of Covid-19 restrictions, many people in the U.S. and other wealthy nations might be under the mistaken impression that the pandemic is over.

However, this couldn’t be further from the truth. Among the unvaccinated (and even some of the vaccinated), Covid-19 is still spreading rapidly, and some variants aren’t impeded by vaccines as much as others are. This means that countries with low vaccination rates are still seeing cases rise, and some are now experiencing their biggest daily increases in new cases.

Take Vietnam, for example. According to data compiled y Alphabet’s Google (GOOG)(GOOGL), Vietnam has recorded more new Covid-19 cases in the past two weeks than at any point in history. Cases in the Philippines hit their peak this past April and remain higher than any point in 2020.

World Health Organization Director-General Tedros Adhanom Ghebreyesus said earlier today that the world is in the early stages of another wave of coronavirus cases, stating that the “global failure to share vaccines, tests and treatments” is fueling a “two-track pandemic.”

So what does the two-track pandemic have to do with the toy supply chain? The answer, it turns out, is everything. Global companies almost always choose to outsource mass production of goods to low-income countries such as Vietnam and the Philippines so that they can pay workers lower wages. This train of logic is why mass production is increasingly being moved out of China and into poorer countries as China’s GDP continues to rise. Toys and other goods produced in countries that are experiencing their worst coronavirus waves yet will naturally have their production delayed.

Shipping bottlenecks

On top of the ongoing pandemic, container shortages and rising shipping costs are causing shipping bottlenecks of goods that are ready to go to their target markets. The bottleneck is most severe between China, which is the world’s biggest producer, and the U.S., which is the world’s biggest consumer.

This problem has its roots at the beginning of the pandemic, when factories were closed and consumers dramatically changed their spending habits, reducing their purchases of things like clothes and buying more electronics. Once factories reopened, they were flooded with orders and ramped up production, but existing global supply chains simply couldn’t handle the transportation of such a high volume of goods in a timely fashion.

Shipping delays are expected to continue through at least late summer, which is the normal peak demand period for shipping as companies ramp up production in anticipation of the holidays.

Which companies are affected?

Even with difficult macro conditions, not all companies will be affected equally. Some toy sellers will be more impacted than others based on where their goods are produced, when they placed their orders, what types of toys they make and many other factors.

So, which toy companies will suffer the most from Covid-19 and supply chain bottlenecks? Are there any that are immune to the industry-wide difficulties?

More than half of the toy factories of Hasbro Inc. (HAS, Financial) and The Walt Disney Co. (DIS, Financial) are in China, so they will be impacted by the supply chain bottlenecks between the U.S. and China. Mattel Inc. (MAT, Financial) has about 65% of its factories in China, so it will also face this headwind. Spin Master Corp. (TSX:TOY, Financial) has most of its production in various East Asian countries, and its sales are more diversified globally, which could lead to complications.

In this environment, there are two main types of companies that will suffer fewer negative effects than competitors: those that produce most of their goods in the same country that they sell them in, and those that have a scale advantage. Most of the former type will be small companies that aren’t publicly listed. The latter type refers to juggernauts such as Amazon.com Inc. (AMZN, Financial), Walmart Inc. (WMT, Financial) and Alibaba Group Holding Ltd. (BABA, Financial). Alibaba has the double advantage of being an e-commerce giant with most of its customers located in the same part of the world as most of its suppliers.

Conclusion

The Covid-19 pandemic isn’t over yet, and global supply chains are still being impacted from the initial lockdowns from over a year ago. So far, supply chain issues have been somewhat mitigated by prior inventory buildup, but analysts are expecting toy supplies (and thus toy sales) in the U.S. to be hurt by transportation bottlenecks right in time for the holidays.

Lower-than-expected holiday sales could be a powerful blow to share prices. Pure-play toy companies that outsource most of their production to the other side of the world, such as Hasbro and Mattel, will likely be the most affected. Thus, investors who are interested in these stocks might see a good buying opportunity following the holiday season.