A hard look at the numbers says there's still no fun at Toys R Us ( TOY).

Sure, the stock jumped 8% Monday as the company posted a smaller-than-expected second-quarter loss and maintained second-half estimates. The upside surprise persuaded at least some investors that a beaten-down stock could be due for a rally, as the company hopes to cash in on long and costly store-renovation efforts.

But some investors contend the company has made little progress on its biggest challenge: competing with the bullies in the nation's toy aisles -- big discounters such as Wal-Mart ( WMT) and Target ( TGT). And while those big retailers continue to impress Wall Street with their strong growth and solid profitability, Toys R Us struggles to regain its balance. With investors now worrying about a late-year consumer-spending pullback, Toys R Us hardly looks like a solid bet to these people.

"They spent $1 billion on this makeover and their comps are still negative," says a hedge fund manager who is short the stock. "They could have spent a billion on T-bills and they would have made more money."

Leaner, Meaner

Toys R Us has been in turnaround mode for some time, since it lost its place as the No. 1 toyseller to Wal-Mart more than 2 1/2 years ago. The company has been pressured by the retail juggernaut's lower prices and massive reach -- deficiencies that some investors say the company is still not remedying.

Toys R Us did make some progress in its latest quarter. On Monday, Toys R Us said it lost 8 cents a share in the second quarter -- analysts had been expecting an 11-cent loss, according to Thomson Financial/First Call. Management said it is comfortable with the current consensus earnings estimate of $1.15 for the full year.

Notably, the company reported leaner inventories, and on a conference call CEO John Eyler said the chain is in good position to boost sales in the second half of the year. This accounted for much of Monday's bullishness. Gerrick Johnson, who covers the company for its underwriter Gerard Klauer Mattison, said Toys R Us has "possibly set the stage for market share gains when the economy improves." Johnson rates the stock buy.


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But comparable-store sales, which measure activity in shops open at least a year, declined 3%. This should be especially jarring for investors, given the company's efforts at remerchandising and remodeling its stores to make them easier to shop.

Paramus, N.J.-based Toys R Us did its best to turn the spotlight away from the same-store sales decline. It highlighted the fact that sales of so-called "core toys," which include electronics and seasonal items like swimming pools, were up 5%.

But core toys account for just 30% of the company's business in the first half and about 50% in the second half. Focusing on this number simply masks the overall weakness in the company's business, contends the forementioned hedge fund manager. "Does Wal-Mart give comps excluding ski parkas in the winter? Of course not."

Toys R Us underwriter Merrill Lynch agreed. Merrill's Peter Caruso, who rates the stock neutral, lowered his earnings estimate for the full year from $1.17 per share to $1.12. He also slashed a dime off his 2003 estimate.

In his report, the analyst notes that consumer confidence has fallen lately. On Monday, Wal-Mart said that sales in August were slowing. This doesn't bode well for Toys R Us, which makes its money in the fourth quarter. The company has acknowledged that it cannot compete on price with Wal-Mart, and instead has focused on higher-priced private label items -- a solid move when the economy is good, but one that could backfire if consumers become even more price conscious.

"We believe that consumer spending will decelerate in the second half of 2002, and in the meantime Toys R Us has taken their average price point up on the category," wrote Caruso in a note published Monday. "We do not believe this will prove to be the correct area to be in given a weakening environment in the second half."