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Many retailers are experiencing an increase in theft in their stores, which is cutting into profits. But 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 a problem in the retail sector. However, the problem has been increasing in recent years. “Shrink” — an industry term that refers to unaccounted for inventory, typically from theft or shoplifting — accounted for $94.5 billion in losses in 2021, according to the most recent data available from the National Retail Federation. That’s up roughly 4% from 2020 and nearly double the $50.6 billion in 2019. Most of the losses were attributed to organized retail crime, employee theft and process control failures. The problem hasn’t gone away in 2023. Talk of earnings “downgrades” has “increased significantly over the past few quarters,” UBS said in a research note this week. Downsizing is a wider trend in the retail sector that has been cited as a drag by CEOs and management teams in food, footwear and clothing retailers. While theft is an industry-wide phenomenon, the diminishing headwinds seemed to have a more material impact on discount retailers. For example, Dollar Tree ( DLTR ) mentioned “elevated attrition levels pose a persistent challenge” during its first-quarter earnings call, and Target ( TGT ) cited “deteriorating attrition rates” as a “significant headwind” weighing on its financial results. in the first quarter. Three retail stocks in Jim Cramer’s Charitable Trust were not immune. Foot Locker ( FL ) said in its fiscal first quarter earnings that its gross margins fell 400 basis points due to a combination of higher promotions and “an increase in theft-related declines.” Off-price retailer TJX Companies ( TJX ) also cited the cut as a gross margin headwind in its latest results. Meanwhile, wholesale retailer Costco ( COST ) said its decline increased only slightly in its latest quarterly results but remains “unchanged.” “Every retailer today is dealing with attrition and working to find ways to minimize the impact,” Dana Telsey, CEO of Telsey Advisory Group (TAG), told CNBC. She added that retailers across the board are adopting security measures and safety protocols to deal with the shock of the shrinkage. “We see that companies are more represented in terms of employees … some of them are putting goods on lock-up.” However, we believe that our retail names are better positioned to address this issue. Tighter control over their inventory, refinement of store surveillance strategies, and simply business models that naturally hedge against this risk all give these stocks an edge over their rivals. TJX, for example, quickly reduced its inventory, helping the lower-priced retailer outperform its competitors. “Some of the retailers that saw the biggest inventory increases are now struggling with the most significant shrinkage issues,” UBS analysts said, citing Target ( TGT ) as one of the hardest hit. Inventory on the balance sheet at TJX was down 8% year-over-year in the most recent quarter. This helped him get rid of excess merchandise and allow for a new influx of newer items. TJX also sought to better secure high-priced items in its stores by placing them in locked cases and using more innovative signage. For example, it added “anti-theft” shackles to more expensive products like handbags and designer clothes; if people try to remove the tag or leave with the item, an alarm will sound. TAG has a $95 price target on TJX stock and an outperform or buy rating on the stock. The club has a price target of $88 and a rating of 1, meaning we would buy the stock here. The Foot Locker advantage is built into the store setup. Only one shoe of each pair is displayed in the front and the rest of the inventory is in the back warehouse. As a result, Foot Locker is “less conducive to shoplifting and shoplifting,” said Tom Nikic, an analyst at Wedbush. In addition, FL stores are located in malls where it is more difficult to shoplift than stand-alone stores. While most of its revenue comes from shoe purchases, Foot Locker also sells clothing, which is more difficult to protect against theft because it’s outdoors. That’s why Nikic said Foot Locker stores “will benefit from having less clothing inventory on the floor.” Foot Locker suffered a number of other blows during the first quarter, including deteriorating consumer demand, particularly from lower-income households, increased inventory and more promotions that weighed heavily on the company’s profits. Management cut its full-year outlook and expects revenue to fall 6.5% to 8% in 2023, down from a previous estimate of 3.5% to 5.5%. Wedbush has a $30 price target on FL stock and a neutral rating on the stock. At our June monthly meeting, Jim emphasized his faith in CEO Mary Dillon’s ability to orchestrate a turnaround at the sneaker retailer similar to what she did at Ulta Beauty ( ULTA ) — but said patience is needed. Costco’s business model is a great defense against theft. A wholesaler requires a membership to shop in their warehouses, and loyal customers tend not to steal. Other factors to consider, Telsey said, are Costco’s bulk offerings — which are harder to steal than smaller individual items at other retailers — and that the typical Costco member is a higher-income shopper. “We didn’t see any major change in attrition,” CEO Rich Galanti said during the company’s earnings webcast, as attrition only rose 3 basis points in the quarter. “We were lucky in that regard. It’s unclear when the increased decline will end, but “as long as there is pressure on lower- and middle-income consumers, the expectation is that this could continue throughout the year,” Telsey said. On the other hand, UBS expects the contraction to improve during the second half of 2023 and into 2024, suggesting it will change “from a headwind to a tailwind.” She added: “This should create a profitability advantage for several hardline, broad and grocery retailers.” Bottom line Attrition has been a big theme in retail this earnings season, but we’re seeing the sector bounce back, particularly in our core retail holdings. It is encouraging to see the industry adopting improved security measures such as additional security, staffing and inventory tracking technology. These steps can help reduce unexpected inventory loss in stores and improve profits. Our retail companies have indeed been affected, but ultimately we believe they are built differently. Basically, our sellers are in a better position to withstand the headwinds of theft. TJX is working on its inventory, and Costco’s membership business model naturally prevents shrinking. Most of Foot Locker’s inventory is out of sight, which could reduce the temptation to steal. However, we need to see more from Foot Locker management as the company has been mismanaged thus far. That’s why we’re looking to see if his turnaround strategy yields positive results, though it will likely take some time to materialize. (Jim Cramer’s Charitable Trust is long TJX, FL, COST. See the full list of stocks here .) As a subscriber to the CNBC Investing Club with Jim Cramer, you’ll receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling shares in his charitable trust’s portfolio. If Jim was talking about stocks on CNBC TV, he waits 72 hours after the trade alert is issued before he executes the trade. 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A shopper carries a bag outside a TJ Maxx store in New York, USA
Victor J. Blue | Bloomberg | Getty Images
Many retailers are experiencing an increase in theft in their stores, which is cutting into profits. But three retail names in our portfolio are built differently than their peers – and are taking the right steps to minimize the damage.