UPDATE 3-Target profit falls; sees sluggish sales growth

Tue May 20, 2008 1:05pm EDT

(Recast, adds company comments, updates stock price)

By Nicole Maestri

NEW YORK May 20 (Reuters) - Target Corp (TGT.N) posted a 7.5 percent drop in quarterly profit on Tuesday, hurt by softer sales as shoppers passed over clothes and home decor purchases in favor of basics like food.

The No. 2 U.S. discount chain behind Wal-Mart Stores Inc (WMT.N) said it expects its sales growth to remain sluggish unless the economic environment improves.

"As gas and food prices continue to rise and (the) housing market slows, consumers are facing increased financial pressure and reducing their spending, especially in discretionary categories," said Gregg Steinhafel, president and chief executive officer, on a call with analysts.

Target said profit was $602 million, or 74 cents per share, for its fiscal first quarter ended May 3, down from $651 million, or 75 cents per share, a year earlier.

Analysts, on average, had been expecting earnings of 71 cents per share, according to Reuters Estimates.

"It paints to me a picture of a company that is feeling the stresses and strains of the economic environment," said Matthew Kaufler, portfolio manager of the Touchstone Value Opportunities Fund, of Target's falling profit.

Target has carved a niche for itself selling cheap but chic designer clothes and home decor, appealing to lower- and middle-income consumers looking for the latest trends.

But as the U.S. economy has faltered, so too have Target's sales, particularly of higher-margin items, as shoppers forgo purchases of new clothes and home furnishings to concentrate on necessities.

Retail sales, excluding credit card revenue, rose 5 percent to $14.3 billion, boosted by new stores openings. But sales at stores open at least a year, a key retail gauge known as same-store sales, fell 0.7 percent.

Its first-quarter gross margin rate declined from last year, driven by faster sales growth in lower-margin merchandise. the company said.

SALES STRUGGLES

Kaufler said Target has become a victim of its success now that shoppers may have to forgo buying those designer items, like Isaac Mizrahi dresses or DwellStudio sheets, for which Target has become known.

He said Target may need to make more room in its stores for the staple items that shoppers seek, or cut its prices to be more competitive.

Target said it is putting a greater emphasis in its ads and in its stores on the "Pay Less" side of its "Expect More. Pay Less." tagline to appeal to shoppers who are feeling the pinch.

Target said that while it does adjust the merchandise in its stores, it does not anticipate making significant changes due to the current climate.

CREDIT CARD REVENUE JUMPS

Quarterly credit card revenue rose almost 20 percent to $500 million.

Target, which has been under pressure from activist investor William Ackman to boost its stock price, said it completed the sale of a 47 percent interest in its credit card business to JPMorgan Chase (JPM.N) for an initial investment of $3.6 billion.

It said the deal would allow it to fund its business plans, including its share repurchase program, without having to access debt markets again this year.

In its latest quarter, Target repurchased 30.5 million shares of its stock. The retailer has been buying back shares as part of a $10 billion share repurchase plan announced in November, and it expects to complete half or more of the stock buyback program by the end of the year.

FOURTH QUARTER SALES REBOUND?

Chief Financial Officer Doug Scovanner expects the retailer's sales growth to remain "sluggish" until the U.S. economic environment improves or stabilizes. He said shopper demand for low profit goods like groceries will continue to pressure gross margins.

Full-year earnings of $3.47 per share are likely within a "reasonable" range of potential outcomes for the retailer, he said, but second-quarter earnings per share could be "somewhat softer" than some analysts' targets of 79 cents.

Analysts, on average, expect earnings of $3.49 for the full year and 78 cents per share for the second quarter, according to Reuters Estimates.

CEO Steinhafel said Target's sales could "rebound" in the fourth quarter, compared with a year ago, when its same-store sales inched up 0.2 percent. He is "hopeful" Target can deliver same-store sales growth in the low-single digits for the final quarter of the year.

Steinhafel also said Target, which operated 1,613 stores at the end of the quarter, remains committed to its new store opening plans unless there is a protracted slowdown in consumer spending.

Target's stock has fallen almost 6 percent in the past year through Monday, while Wal-Mart is up 19 percent and the Standard & Poor's Retail Index .RLX is down 21 percent.

Target shares declined 45 cents at $54.47 in afternoon New York Stock Exchange trading. (Reporting by Nicole Maestri, editing by John Wallace and Dave Zimmerman)

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