Another department store bets on toys: Kohl's

The iconic Toys R Us chain will close for good this summer, at least in the United States. Its impending disappearance will leave a huge vacuum in the toy market, giving other retailers an opportunity to gain market share. While discounters like Target are likely to make the biggest market share gains, department stores are also eager to get in on the action.

Nearly a year ago, J.C. Penney(NYSE: JCP) installed toy shops in all of its stores. The timing was fortuitous, and it will give J.C. Penney a great opportunity to earn incremental sales. Last week, Kohl's(NYSE: KSS) revealed that it too plans to capitalize on the demise of Toys R Us by diving into the toy market in time for the 2018 holiday shopping season.

Starting almost from scratch

Kohl's does have toy sections in its stores today, but they aren't very impressive. At a Kohl's location I visited recently, the toy section took up a tiny corner of the store. The bulk of the displays seemed to be devoted to dolls and action figures.

Kohl's currently has a very small selection of toys in its stores. Image source: Author.

By contrast, J.C. Penney's toy sections are larger. They feature a much greater variety of merchandise from most of the top brands, including Mattel, Hasbro, LEGO, and Playmobil. J.C. Penney also has Disney shops adjacent to its toy sections. (Those shops were one of the few successful innovations under former CEO Ron Johnson.)

J.C. Penney is certainly no Toys R Us, and it's not even in the same league as Target in the toy category. Nevertheless, it has a broad enough selection to generate a decent volume of sales. Right now, Kohl's can't say the same thing.

Kohl's gathers brands looking for shelf space

On Kohl's recent first-quarter earnings call, CEO Michelle Gass revealed that the company will significantly expand its toy selection in September. It will add products from two well-known toy brands: LEGO and FAO Schwarz. This will make Kohl's a much more attractive place to shop for toys.

Both LEGO and FAO Schwarz are desperate to find more shelf space for their products. LEGO posted its first annual sales decline in more than a decade last year, due to an inventory overhang from 2016. The Toys R Us liquidation will add to its woes. LEGO put its products in J.C. Penney stores starting last November in an effort to snap out of its sales slump. Adding Kohl's as a retail partner is a logical next step.

J.C. Penney added LEGO to its roster of toy suppliers last November. Image source: J.C. Penney.

Meanwhile, FAO Schwarz has an even greater need to find new shelf space. The storied brand was owned by Toys R Us from 2009 until 2016, when it was sold to a private company that is expanding its distribution.

Unfortunately, FAO Schwarz's new owners bet on the wrong horse in the U.S. Struggling department store owner Bon-Ton Stores added FAO Schwarz-branded toy shops to 200 stores last November. However, like Toys R Us, Bon-Ton is currently liquidating its stores and will disappear from the U.S. retail landscape within the next few months. With two key retail partners going out of business, FAO Schwarz urgently needed to find new domestic sales outlets.

FAO Schwarz's upmarket image doesn't fit perfectly with Kohl's moderate-income customer base. That said, Kohl's brings a broad national footprint to the table, and it will do a much better job of protecting the FAO Schwarz brand than a discount chain.

Another sales growth driver for Kohl's

After several years of stagnant sales, Kohl's posted stellar comp sales growth in the final quarter of fiscal 2017. That momentum continued in early 2018, particularly in markets that didn't experience snowstorms or unseasonably cold weather during March and April.

Many investors seem to doubt that Kohl's recent revival is sustainable. However, the company is well positioned to continue gaining market share as struggling rivals close stores. (It has also rolled out some intriguing strategies to boost store traffic.) By partnering with two prominent brands to expand its selection of toys, Kohl's is seizing yet another opportunity to drive sales growth in the second half of fiscal 2018 and beyond.

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Adam Levine-Weinberg owns shares of J.C. Penney and Kohl's. The Motley Fool owns shares of and recommends Hasbro and Walt Disney. The Motley Fool has a disclosure policy.