The commonly referenced retail overhang known as shrink may finally be shrinking itself.
In a new note to clients on Tuesday, UBS analyst Michael Lasser wrote shrink — or merchandise theft — at retail chains might be at "peak" cycle in what has been a cyclical trend.
"The impact of shrink will turn from a headwind to a tailwind later this year and into next year," Lasser wrote. He added that this should result in a boost to profitability for a variety of retailers.
Shrink has been a challenge for companies such as Target (TGT), Walmart (WMT), Dollar General (DG), Dollar Tree (DLTR) and others for several quarters. In the most recent quarter, Target estimated it would lose $500 million in profits this year to shrinkage.
"Worsening shrink rates are putting significant pressure on our financial results," Target Chairman and CEO said in May.
But history shows the more executives talk about the shrinkage, the closer it is to a peak, according to UBS. Shrink mentions on earnings calls are at their highest levels since before the pandemic, per UBS, and that likely means shrink declines for the rest of 2023 and into 2024. In turn, a drop in shrink issues would be an upside to gross margins and profitability at some of the hardest-hit stores.
UBS points out Target, Walmart Dollar General, Dollar Tree, Home Depot (HD), Ulta (ULTA) and Kroger (KR) could all benefit from lowering shrink levels.
"Ultimately, shrink is a cost (albeit in some cases, a steep one) much like occupancy, utilities and others," Lasser wrote. "The managers of these companies have a fiduciary responsibility to maximize profits. We believe they will find solutions to address these issues and lower the costs in the quarters to come."
Retailers on average saw a 26.5% increase in Organized Retail Crime in 2021, according the National Retail's Federation most recent survey. One contributor to the rise in retail crime has been the increase in online shopping during the Covid-19 pandemic.
"The fast deployment of initiatives like curbside pickup created more opportunities for slippage," Lasser said.
UBS argues companies have also been behind on hiring, too. The firm notes average retail revenues have increased 41% between 2019 to 2022. But in that time, employee headcount increased by just 19%.
Some companies will fix this problem and bring hiring back to normal levels,UBS says, which will "better equip stores" to address shrink. They could also turn to artificial intelligence.
Retailers "have increasingly called out making new investments in technology when addressing their plans to tackle shrink," Lasser wrote. "This should benefit the retailers as they increasingly incorporate the latest anti-shrink technologies and solutions that incorporate AI-enabled insights."
In the companies most recent earnings call, Dollar Tree's executive team repeatedly mentioned shrink putting pressure on margins. The company reported an adjusted earnings per share of $1.47, attributing a $0.14 hit from shrink. Executives there see technology as a potential solution, too.
"We introduced new technologies within the store, how we monitor and alerts," Dollar Tree CFO Jeff Davis said on the company's most recent earnings call on May 25. "We take such steps, quite honestly, in working more closely with local law enforcement to the extent that there [are] elevated levels."
Davis also referred to shrink on the earnings call as "cyclical." And if that holds, UBS sees opportunities for investors in the back half of this year.
