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Target, Battling $600 Million Crime Wave, Joins $250M Climate Fund

Crime took a bite out of Target’s margins this year.

The Walmart rival blamed “criminal networks” for much of the $400 million gross-margin impact from shrink it reported so far this year that could reach $600 million before January.

In more positive news, the Apparel Impact Institute said Target joined its $250 million Fashion Climate Fund as a lead funder alongside industry giants including H&M, PVH and Lululemon. The climate-action initiative aims to get fashion emitting 50 percent less emissions by 2030.

In a Nutshell: Target ended the quarter with $17.1 billion of inventory, or $5.7 billion higher than the end of the third quarter of 2019 in percentage terms. One-third of the inventory amount came from goods arriving earlier than planned

“Compared with the second quarter, lead times improved by about 15 percent in Q3, and we’re more than three weeks shorter than a year ago,” Target chief operating officer John Mulligan told investors during a conference call on Wednesday.

“The team has implemented multiple strategies and tactics, including new processes to efficiently segment shipping containers as they arrive at domestic ports, allowing early arriving containers to age before sending them downstream into our regional distribution centers,” Mulligan said.

Transportation costs have let up even if they’re still above where they were before the pandemic, and container rates and global shipping are “down by about one-third in recent months,” Mulligan pointed out, adding Target should see this impact when it renegotiates its “staggered contracts with shipping partners.” These costs are still “three times higher than we were paying in 2019,” he said.

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Other rate improvements include domestic transportation costs, although still double the rate in 2019, while fuel costs continue to be more than double the amount in 2019.

Mulligan said Target continues to build out its sortation center strategy. The six centers it operates plus those opening next year will drive cheaper, faster delivery, he added.

Target will end the year with 23 new stores ranging from 19,000 to 145,000 square feet. The company is also testing a nearly 150,000-square-foot store prototype in the Houston area with five times more space to support omnichannel services including curbside pickup. In addition to testing a Starbucks drive-up feature as an add-on to digital fulfillment services, Target is trialing returns via drive-up.

The retailer is trying to figure out what consumers want. “We’re moving proactively in a period of rapidly softening demand and elevated uncertainty to successfully navigate near term challenges,” Target chairman and CEO Brian Cornell told Wall Street analysts.

“Consumers are showing increasing signs of stress and pulling back from discretionary purchases,” Cornell said, adding a consumer focus on groceries and staples drove a “persistent softness” in discretionary categories, which “worsened at the end of the quarter.”

Comp growth for the quarter started at well over 3 percent, but slowed to 0.9 percent last month as shoppers prioritized promotions instead of paying full price

“Consumers are feeling increasing levels of stress driven by persistently high inflation, rapidly rising rates and an elevated sense of uncertainty about their economic prospects,” Cornell said, adding that consumers have been “borrowing or dipping into their savings to manage their weekly budgets. But for many consumers, those options are starting to run out.”

“Q3 profitability came in well below our expectations,” he said, noting that the higher promotional sales garnered in the quarter eroded gross margin rates.

Cornell called out this year’s massive “organized retail crime” wave, saying “we’re facing a growing financial headwind” from shrink, “which is running hundreds of millions of dollars higher than a year ago.”

“In addition, we’d expect greater marked down pressure from Q4 promotions, given the increase in price sensitivity our guests have shown recently and our commitment to end of the year with a clean inventory position,” chief financial officer Michael Fiddelke said, adding that “we’re planning for additional pressure from inventory shrink, given the worsening trends that have emerged so far this year.”

Shrink has already reduced Target’s gross margin by more than $400 million versus last year, he said, and “we expect [it to] reduce our gross margin by more than $600 million for the full year.”

Cornell added that Target is “undertaking an enterprise wide effort to identify opportunities to simplify and enhance the efficiencies of our business.”

Net Sales: For the three months ended Oct 29, net sales grew 3.3 percent to $26.12 billion from $25.29 billion.

Christina Hennington, chief growth officer, said consumers are trading into smaller pack sizes when shopping food and grocery, opting for large pack sizes to stock up when items are on promotion or switching to private label to reduce their spending.

“These trends only became more pronounced towards the end of the third quarter when spending patterns changed dramatically, with inflationary food prices absorbing more of their spending. Those costs are crowding out other categories including spending on discretionary items, and in some cases, even household essentials,” she said. “Already soft sales trends in our discretionary categories softened even more in the last few weeks of the quarter, a trend that’s persisted into the first few weeks of November.”

Hennington said apparel comps were down only slightly in the third quarter, driven by growth in kids. men’s seasonal and new fashion forward assortments offset by softness in swim, women’s accessories and basics. In home, sales declined in the mid-single digits, despite strong performance in seasonal areas.

What could be troubling for the holiday season was a “meaningful deceleration in toys this quarter, most notably in October. This is a trend we will continue to monitor closely as we move throughout the holiday season,” she said.

“We’re taking a prudent approach to our inventory planning and sales expectations for the fourth quarter, in light of the concerning industry trends we’ve seen over the past several weeks,” Hennington said.

For the holidays, Target is planning a number of specials for the season, including a partnership with British retailer Marks & Spencer for a limited time assortment of premium food and chocolates.

For the nine months, net sales rose 3.5 percent to $76.61 billion from $74 billion.

Earnings: Net income for the quarter fell 49.5 percent to $712 million, or $1.54 a diluted share, from $1.49 billion, or $3.04, in the same year-ago period.

Wall Street was expecting adjusted diluted earnings per share of $2.13 on revenue of $26.38 billion.

CFO Michael Fiddelke said third quarter gross margin rate was 24.7 percent.

“We anticipated a highly promotional environment this fall given the excess inventory we’ve been seeing across retail. This enhanced focus on promotions reflects an increasing level of stress on consumers as they navigate through multiple headwinds. including persistent inflation and rapidly rising interest rates,” Fiddelke said.

For Fiscal 2022 outlook, he said Target is planning for a wide range of comparable sales outcomes in the fourth quarter that center around a low single digit comp decline around 3 percent, consistent with recent trends.

For the nine months, net income dropped 62.5 percent to $1.90 billion, or $4.09 a diluted share, from $5.40 billion, or $10.87, a year ago.

CEO’s Take: “We’re also taking new actions to drive efficiencies now and in the future, optimizing our operations to match the scale of our business and drive continued growth. The strides we have made in recent years to build a truly differentiated, guest-centered retail offering, punctuated by a balanced, multi-category portfolio, positions us well to navigate in any environment,” Cornell said.