Target 4Q profit falls 41 percent amid downturn

Sales at Target stores open at least a year, a key gauge of a retailer's health, dropped about 6 percent. Meanwhile, Target's net income fell about 40 percent to $609 million for the quarter. During the same three-month period the nation's unemployment rate jumped by nearly a full percentage point.

Morningstar retail industry analyst Joseph Beaulieu said Target suffered as consumers held out for sale prices and concentrated on buying food and other lower-profit staples.

"There was a much bigger shift from discretionary items toward consumables," Beaulieu said. "That really weighed on the gross margins. Then I think they had to do a bit more discounting in order to move the merchandise they did move, and they obviously got killed on the credit card business."

Target's credit card division posted a $135 million pre-tax loss in the quarter. That was because Target set aside nearly $250 million to cover possible defaults by customers who might end up not paying their credit cards bills in coming months.

Target chief financial officer Doug Scovanner said Target saw signs of a big uptick in credit card defaults to come.

"In our credit card segment we experienced sharp increase during the fourth quarter on a wide variety of leading indicators of future risk," Scovanner said. "While our write-offs in dollars were in line with our expectations, these risks compelled us to add meaningfully to our reserves for future credit losses."

But Scovanner said Target is confident it has now set aside adequate reserves to cover possible credit card defaults for the foreseeable future.

Target has also been hiking fee and interest rates for customers who get behind in their payments. Target will now charge those customers annual interest rates of up to 30 percent.

Burt some industry analysts aren't so sure Target's credit card woes won't get worse. Dave Heupel is an analyst with Thrivent Financial for Lutherans.

"The bottom line is the consumer is still in tough shape and doesn't seem to be getting any better," Heupel said. "So you're going to see delinquencies and some of those other metrics deteriorate. Despite the efforts that Target and all the other credit card companies have been trying to do now."

Target's credit card problems prompted the Standard & Poor's Ratings Services to downgrade its overall outlook on Target to negative.

A Standard & Poor's credit analyst said he expects Target's bad debt expenses to remain high in 2009 as a result of the weak economy.

During a conference call with analysts, Target executives vowed they'll compete vigorously with Wal-Mart and other stores when it comes to prices. And they said they'll sell more food and basic goods that are less affected by hard times. Of course, those item are also less profitable.

Kathryn Tesija is Target's executive vice president for marketing. She said Target is determined to erase any perception that the company doesn't go toe-to-toe with Wal-Mart on price.

"We are priced within one to two percentage points of Wal-Mart on like or identical items within local markets," Tesija said. "However, guest perceptions do not reflect this reality."

Those perceptions will be difficult to change. Retail consultant Howard Davidowitz said consumers firmly believe Wal-Mart is the price leader. And, Davidowitz said there's not much Target can do to match Wal-Mart's strength in groceries or Wal-Mart's greater focus on basic goods that consumers tend to keep buying in hard times.

"Wal-Mart is the one that has the price image," Davidowitz said. "That's the bottom line for the consumer. Number two, Wal-Mart is the one that has the food penetration, and Target is 500 miles behind them. Wal-Mart is the largest food retailer in the United States. Target is a midget."

For the first half of 2009, Targets said same-store sales will likely drop, falling in the range of 4 to 6 percent. The retailer said earnings will be down from last year.

Target's shares were down two percent today, closing at $27.83.

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