How our retail stocks are battling a rise in theft — and why they are set up to win

Many retailers are grappling with a rise in theft at their stores that is cutting into profits. But the three retail names in our portfolio are built differently than their peers — and are taking the right steps to minimize the damage. Theft has always been an issue in the retail sector. In recent years, however, the problem has escalated. “Shrink” — an industry term that refers to unaccounted for inventory, typically from theft or shoplifting — represented $94.5 billion in losses in 2021, according to the most recent available data from the National Retail Federation. That’s up about 4% from 2020, and almost double the $50.6 billion in 2019. Most losses were attributed to organized retail crime, employee theft and process-control failures. The problem hasn’t gone away in 2023. Mentions of “shrink” in earnings calls “spiked significantly over the last few quarters,” UBS said in a research note this week. Shrinkage has been a broader trend within the retail sector that’s been cited by CEOs and management teams at grocery, footwear and apparel retailers alike as a drag on bottom lines. While theft is an industry-wide phenomenon, the shrink headwind appeared to have more of a material impact among discount retailers. For example, Dollar Tree (DLTR) mentioned “elevated levels of shrink present a persistent challenge,” during its first-quarter earnings call and Target (TGT) called out “worsening shrink rates” as a “significant headwind” that pressured its financial results in the first quarter . The three retail stocks in Jim Cramer’s Charitable Trust have not been immune. In its fiscal first-quarter earnings , Foot Locker (FL) said its gross margins declined by 400 basis points due to a mix of higher promotions and “an increase in theft-related shrink.” Off-price retailer TJX Companies (TJX) also cited shrink as a headwind to gross margins in its latest results . Meanwhile, wholesale retailer Costco (COST) said its shrink only slightly increased in its most recent quarterly results , but remains “intact.” ” Every retailer today is dealing with shrink and working to figure out ways to minimize the impact,” Dana Telsey, CEO of Telsey Advisory Group (TAG) told CNBC. She added that retailers across the board are taking security measures and safety protocols to address the shrinkage shock. “We’re seeing companies put in more of a presence in terms of employees … some of them are putting goods on lock and key.” However, we believe our retail names are better positioned to tackle the problem. Tighter control over their inventories, improving strategies on store surveillance and simply having business models that naturally hedge against this risk all give these stocks an edge over rivals. TJX, for example, has been quick to reduce its inventory, helping the off-price retailer to fare better than competitors. “Some of the retailers that experienced the greatest growth in inventory are now contending with the most significant issues with shrink,” UBS analysts said, citing Target (TGT) as one of the hardest hit. Balance sheet inventory at TJX was down 8% year-over-year in its latest quarter. This helped it offload excess merchandise to allow a fresh flow of newer items. At its stores, TJX has also made efforts to better secure expensive merchandise by putting it behind locked cases and using more innovative tagging. For example, it has added “anti-theft” tethers on more high-priced products like handbags and brand clothing; if people try to remove the tag or walk out with the item, an alarm will go off. TAG has a $95 price target on TJX stock and an outperform, or buy, rating on shares. The Club has a price target of $88 and a 1 rating , meaning we’d buy shares here. Foot Locker’s advantage is built into its store setup. Only one shoe of each pair is out front for display, with the rest of the inventory in the back storeroom. As result, Foot Locker is “less conducive to theft and shop lifting,” said Tom Nikic, an analyst at Wedbush. Moreover, FL stores are based in malls, where it’s more difficult than standalone shops to shoplift. While the bulk of its revenue comes from shoe purchases, Foot Locker also sells apparel that’s more challenging to safeguard from theft since it’s out in the open. That’s why Nikic said Foot Locker stores would “benefit from having less apparel inventory sitting out on the floor.” Foot Locker suffered a series of other blows during the first quarter, including deteriorating demand from consumers, particularly from lower-income households, elevated inventory and more promotions that weighed heavily on the company’s profits. Management lowered its full-year forward guidance and expects 2023 sales to fall 6.5% to 8%, down from its previous guide of down 3.5% to 5.5%. Wedbush has a $30 price target on FL stock and a neutral rating on shares. In our June Monthly Meeting , Jim stressed his faith in CEO Mary Dillon’s ability to orchestrate a turnaround at the sneaker retailer in a manner similar to what she did at Ulta Beauty (ULTA) — but said patience is required. Costco’s business model makes for a great defense against theft. The wholesale retailer requires a membership to shop at its warehouses, and loyal customers tend not to shoplift. Other factors to consider, said Telsey, are Costco’s bulk offerings — which are harder to steal than smaller, single items at other retail stores — and that the typical Costco member is a higher-income shopper. “We haven’t seen any major change in shrinkage,” said CEO Rich Galanti during the company’s earnings webcast, as shrink rose only 3 basis points for the quarter. “We’ve been fortunate in that regard.” It’s unclear when elevated shrink will pass but “as long as there’s pressure on the lower-end and middle-income consumer, there’s an expectation that it could continue through the year,” Telsey said. UBS, on the other hand, expects shrinkage will improve through the second half of 2023 and into 2024, suggesting it will turn “from a headwind to a tailwind.” She added: “This should create a profitability benefit for several hardline, broadline and food retailers.” Bottom line Shrinkage was a huge retail theme this earnings season, but we see the sector bouncing back, especially at our core retail holdings. It’s encouraging to see the industry taking enhanced safety measures, such as additional security, staff and technology to monitor inventory. These moves can help reduce the unexpected loss of inventory in stores and improve profits. While our retail companies have indeed been impacted, we ultimately believe they’re built differently. Fundamentally, our retailers are better positioned to weather the theft headwind. TJX is working through its inventory and Costco’s membership business model naturally prevents shrink. A majority of Foot Locker’s inventory is not visible, which could lessen the temptation for theft. However, we need to see more from Foot Locker’s management because, so far, the company has been poorly run. That’s why we’re looking to see if positive results come through from its turnaround strategy, even though that will likely take some time to materialize. (Jim Cramer’s Charitable Trust is long TJX, FL, COST. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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