By  on August 19, 2008

With the weakening economy, Target has been walking a delicate tightrope, trying to convince consumers its prices are as low as Wal-Mart’s while touting its designer partnerships and style-driven products. Target Corp.’s second-quarter financial results, released Tuesday, indicate the retailer hasn’t quite convinced consumers they’ll find the bargains they seek.

Net earnings in the quarter ended Aug. 2 were down 7.6 percent to $634 million, compared with $686 million in last year’s second quarter. Earnings per share increased 2.4 percent to 82 cents, from 80 cents in the 2007 period.

Sales in the second quarter grew 5.7 percent to $15 billion, from $14.2 billion in 2007, due to the contribution from new store expansion. But same-store sales at the Minneapolis-based chain declined 0.4 percent for the second quarter, reflecting shoppers’ cautious approach to spending.

“The pace of sales growth continues to be our number-one challenge,” said Douglas A. Scovanner, executive vice president and chief financial officer on a conference call. He noted that for the last three quarters, comp-store sales have hovered slightly above or below zero, with store traffic down 1 to 2 percent.

“As we look across the next several quarters, sales growth will be the number one factor in determining our overall performance,” he added.

Scovanner said the average transaction size rose in the second quarter, driven by higher average retail prices per unit, but this was offset by a decline in the number of trips consumers made to stores and a decrease in the number of categories they visited. The biggest declines in store traffic were recorded in discretionary spending categories such as apparel and home.

Not surprisingly, Target is pushing its “Pay Less” message. Store signage, endcaps filled with low-priced items and weekly circulars featuring spreads with fewer products on each page, bigger images, bold price points and strong value headlines are among the tactics the retailer is using to lure shoppers.

“We’re increasing our emphasis on Pay Less,” said Greg W. Steinhafel, president and chief executive officer. “We’re making sure our prices are the same as Wal-Mart’s on identical products.” Wal-Mart, however, last week turned in a much stronger performance in its second quarter, registering double-digit increases in profits and sales.

“In this very hostile environment it was a very respectable performance,” Walter Loeb, president of Loeb Associates, said of Target’s second quarter. “Their earnings were above expectations, they lowered SGMA and bought back a lot of stock, which helps earnings.”

“Target’s in a very difficult spot right now because they don’t sell as much food as Wal-Mart does,” said Bill Dreher, a retail analyst at Deutsche Bank. “The discretionary merchandise simply is not moving now. The perception is that they’re [Target], not the rock-bottom bargain basement price.”

Target may be emphasizing low prices, but it’s not abandoning its design-driven approach. “Great design is part of our DNA,” said Kathryn A. Tesija, executive vice president of merchandising. “We are continuing to differentiate our products.”

Yet Steinhafel conceded shoppers are “very cash-strapped now. Our greatest strength has become somewhat of a challenge in that our stores are fun and unique and we have both what you need and what you want. In these economic times, some of our consumers don’t want to be tempted.”

Target nonetheless hopes customers will be lured by the launch of its new Go International private label collection next month, followed by new designer partnerships in October with Jonathan Saunders for apparel, Anya Hindmarch for handbags and Sigerson Morrison for shoes. Next week, Target will introduce three designer-driven cosmetics lines from Gemma Kidd, Pixie and Napoleon Perdis. “We have significantly evolved our beauty offerings,” said Tesija. “Guests will buy relatively higher price points in beauty, despite the economy.”

To showcase the new brands, Target will open four pop-up stores, or “bullseye bodegas” as the retailer calls them, in New York in Midtown, Union Square, SoHo and the East Village on Sept. 11.

Target is implementing a segmentation strategy to customize assortments, timing, presentation and space allotment to individual stores and local preferences. Steinhafel said this initiative will continue to contribute to margin results. “We are also capitalizing on the opportunity of our share price to engage in substantial share repurchase, which we believe will generate significant value for our shareholders over time,” Steinhafel said.

The retailer plans to open 45 stores in October, including its first two units in Alaska. Target will enter Hawaii in 2009. However, the company is reducing its projected new store count for 2008 and 2009 by 20 units and lowering capital expenditure for the two years by $1 billion to between $4.1 billion and $4.3 billion for each of 2008 and 2009.

“We’re modestly reducing our expected store openings as a result of the difficulties developers are facing,” said Scovanner. “Many of our external development partners have experienced challenges in obtaining funding and/or filling in-line space in certain large power center projects that were anticipated to open in 2009.”

Target’s credit card business is challenging, with an annualized net write-off rate of 8.7 percent in the quarter, higher than the 7.7 percent the company projected.

Profits in the credit card division declined 65 percent to $74 million from $213 million in the same period a year ago, due to a decline in overall portfolio yield and Target’s reduced investment in the portfolio. The average receivables directly funded by Target in the second quarter dropped 19.8 percent to $3.6 billion from $4.5 billion a year ago, reflecting the impact of J.P. Morgan Chase’s investment, partially offset by a $1.8 billion increase in average receivables.

Target’s shares on Tuesday closed at $49.72, down 33 cents, on the New York Stock Exchange.

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