Target’s Shrinkage Problem Creates Opportunity for Investors

Key Points

• Target is the poster child for rising shrinkage and its impact on profits. 
• Membership clubs like  Costco and Walmart's Sam's Club are immune to the issues. 
• The analysts have set the bar for Target low; efforts to combat shrink could result in bottom-line strength and catalyze the market. 

The National Retail Federation reports that retail theft, often referred to as shrinkage, is up 20% YOY in 2023, costing retailers more than $110 billion in profits. This significant figure hurts names like Target NYSE: TGT the most. Based on details from Target’s previous 3 earnings reports, it almost looks like thieves are targeting the store for a reason. 

The company first reported shrinkage as an issue in the Q4 2022 release, and the details worsened as the 2023 fiscal year wore on. The Q1 results include rising levels of theft leading to decreased profit guidance, a half billion worth, and the guidance was lowered again after Q2 for the same reasons. Since then, the company announced closing 9 key locations because of insurmountable levels of theft, begging the question why. 

“As we look ahead, we now expect shrink will reduce this year's profitability by more than $500M compared with last year. While there are many potential sources of inventory shrink, theft and organized retail crime are increasingly important drivers of the issue,” CEO Brian Cornell said.

At face value, the drivers of increased shrink are rising inflation, high-interest rates, and the increasing cost of basic living. Oddly, companies like Costco NYSE: COST conspicuously report no impact from rising shrinkage again, asking why Target is suffering so badly, and the answer may be simple: Target’s newer store layouts rely heavily on self-checkout, and there is insufficient coverage watching the front door. This makes it an easier target than the membership clubs, which not only regulate (to some degree) who enter, but membership is required to purchase, and they utilize door monitors and check tickets as you leave. 

Costco Has Strong Quarter: CFO Says Shrink Not A Problem

Costco reported a notably strong quarter for FQ3/CQ4, with revenue up 9.5%, earnings up 15%, and both better than expected compared to Target’s weak showing. There are more reasons than theft to drive the disparity, but theft is a significant factor. Where Target continues to report significant impacts, Costco’s CFO has stated several times this year that shrink is not a concern. According to him, Costco’s shrink rose a few basis points ahead of and at the beginning of the pandemic due to it bringing back self-checkout. Still, security measures keep the figure in a tight range, and there has been no significant increase this year. 

Walmart Growing, Raises Guidance 

Walmart NYSE: WMT is doing a better job with its shrinkage than Target, aided partly by its Sam’s Club segment, but all segments are performing well. The company reported top and bottom-line growth, with revenue up 5%,  compared to Target’s 5% decline, and the profitability outlook is much better. 

Target outperformed on the bottom line and produced YOY earnings growth due to inventory normalization, while Walmart is growing earnings organically. More importantly, Walmart raised guidance and can be expected to outperform in CQ4. In contrast, others, including names like Dick’s Sporting Goods NYSE: DKS, which also reported significant issues with theft, are more likely to continue suffering. 

Is There Hope for Target? An Opportunity is Brewing 

Believe it or not, all is not lost for Target. The company’s financials are in fine shape, and it is trying to combat its problems. The company has begun to improve front door security and other efforts, including locking cases for high-theft/high-cost merchandise and digital inventory tracking. 

The takeaway is that analysts have been lowering the bar for Target results over the past 2 months and may have set it too low. With shares down more than 50% from the high, the stock trading at only 14X earnings and paying more than 4% looks like a good time to make a small purchase. 

A sign of margin strength, specifically positive updates on shrinkage, could catalyze this market. Shares of Target offer a deep value and high yield at current levels, and the analysts only see an upside for the market. The low analyst price target is 5% above the current action, and the consensus is about 40%. 

As it is, the consensus expects a 5% decline in YOY revenue and a 3.5% decline in earnings. It is unlikely Target will reclaim lost share from competitors like Walmart and major grocery chains in a single quarter. Still, this high-yield Dividend King could outperform the analysts' consensus on the bottom line.