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Target Hits the Mark

The retailer soothes fears with impressive sales and margins.

As expected,


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continues to hit the bull's-eye with its performance.

The retailer's first-quarter results handily

topped estimates, thanks in part to solid inventory control and healthy same-store sales growth.

Target's management even managed to achieve the impossible and largely quell the fears of this gloomy Gus analyst.

I can be a nattering nabob of negativity, and in my

earnings preview on Target, I raised two potential concerns: the company's margins and its credit card business.

Margins were impressive. I'll get to that in a moment. But first let's discuss the company's credit card business, which is becoming an increasing percentage of revenue. In my glass-half-empty world, that's the one red flag.

First-quarter revenue totaled $14.04 billion, with credit card revenue comprising $418 million of that total. The $418 million represented a 13% growth rate over last year, when the company logged 21% growth in credit revenue.

I'm actually relieved to see the growth rate slow. While credit revenue is a nice and profitable addition to the income statement, I don't want to see Target get away from its core business as a merchant.

Credit card contribution to earnings before taxes, or EBT, drifted higher by 13 basis points to 13.44%, as the net interest margin on that segment ticked up. This a highly profitable business; while it contributed less than 3% to revenue, it made up more than 13% of Target's EBT.

Delinquent accounts edged upward to 3.2% from 3% a year ago, although that figure was down from 3.5% in the fourth quarter. Net write-offs, which grew steadily in 2006, remained stable at 6% in the first quarter. The allowance for doubtful accounts, which gauges bills that likely won't be paid, also remained steady at 7.7% and aren't expected to vary from those levels.

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On Target's conference call, management said it expects "some modest adversity" in write-offs, which it has provisioned for. So there are fewer write-offs than expected, the company's profit margin should benefit.

My concerns about credit cards haven't changed. While Target is managing the business well, this segment deserves close scrutiny in the future, given the volatility it faces.

On the margin side, Target did a stellar job. The company improved gross margin by 39 basis points over the year-ago period, boosted by fewer markdowns and good cost control. The company also recorded a $12 million telephone excise tax refund, which added a penny per share to earnings.

The reduction in markdowns came amid solid inventory control. Product turnover increased for the third consecutive quarter. Inventory-level growth of 5.9% was below merchandise-sales growth of 9% and square-footage growth of 7.1%.

It also helped that people bought what Target was selling. Same-store sales rose a healthy 4.3%, and they are expected to jump 5% to 7% in the second quarter.

The results continue to compare very favorably to


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, which has inventory issues as racks of its designer clothing go unsold.

So I'm staying positive on Target. It's a well-run company and the stock is still cheap. But keep an eye on those credit cards. You know I will.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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