may have made discount shopping cool, but that isn't what keeps the stock hot.
The Minneapolis-based retail chain has created an enviable buzz by selling rhinestone sandals and Mossimo shirts on the cheap. But peddling Michael Graves tea kettles isn't the difference between Target and the retail also-rans. Increasingly, some investors warn, Target's profits are coming from its booming credit card unit.
Pushing plastic has been kind indeed to Target. In the latest quarter, retail sales grew a solid 14% from a year ago -- but credit revenue surged 74% as the company rolled out a Target Visa card that holders can use anywhere. Credit-quality scores remain high, suggesting the company hasn't taken on too many less-creditworthy borrowers.
Even so, some analysts worry about the credit operation's expanding profile. They say they prefer to see a retailer's growth come from selling merchandise -- which Target has proven it has few peers in -- rather than the hard-to-predict, high-risk credit business. If Target can't keep growing the credit segment at its heady recent clip, investors and analysts say, it will have to find growth elsewhere to justify its premium valuation.
"It does raise the overall risk of the company," says Eric Beder, of Ladenburg Thalman, who has a market perform rating on Target. The stock, which trades at about 22 times earnings estimates, rose $1.40 Friday to $41.90.
Stakes Are Higher
Doug Kline, Target's top spokesman, declined comment for this article. But Target has long assured investors that it is conservative in doling out credit and that it has a solid track record of avoiding delinquencies.
Indeed, Target is more conservative than its peers in its allowances for bad debts. Its allowance at the end of 2001 was 6.4% of receivables, compared with 3.4% for
and 4% for
, according to Lazard Freres. Meanwhile, the company's risk-return ratio is the most favorable among retailers that offer credit cards, says Sanford Bernstein's Emme Kozloff.
But Target's very strength, the broad mix of products that draws shoppers from all walks of life, could be a source of credit headaches as the company continues to grow, say observers.
*2002 and 2003 estimated figures.
"I think what Target has to be concerned about is its particular demographic mix of customers," says David Robertson, president of the Nilson Report, a credit card newsletter.
Target has attracted a more upscale clientele than traditional discounters such as
, observers say. But it is still a discounter, which inevitably means a huge customer base that includes some people with poor credit histories.
The stakes are only getting higher with Target's entrance into the Visa card business. While many retailers offer in-store charge cards, Target also offers a Visa card that consumers can use at any business that accepts Visa, and it runs the business itself. Store cards are typically used to drive in-store sales, but launching a Visa card is much more ambitious.
"The importance here is that Target has therefore jumped head-first into the credit game," says Rob Wilson, a former executive at
who now runs Retail Stock Investor, a research firm that focuses on retail stocks. "Store-branded cards are meant to target lower credit quality customers that may have already tapped out their traditional credit lines to induce them to purchase that appliance they don't need."
Target has said it is taking advantage of the best technology to judge creditworthiness, which will help it avoid the credit problems some its rivals have faced in the past. But some observers aren't persuaded that dodging potential deadbeats is that easy.
"They're gambling on the current state of technology," Robertson says. He says this so-called credit criteria technology "is available to anyone for a price," meaning Target may have difficulty maintaining a significantly better credit profile than its peers.
The ebbs and flows of the credit business should be apparent to longtime retail investors. The two big retailers that own their credit operations, Sears and Federated, have in recent years suffered well-publicized setbacks stemming from big jumps in delinquencies. For that and other reasons most retailers, such as
-- which sold its card operations in 1999 to GE Capital -- prefer to outsource the credit business.
That fact has some retail observers wondering if Target investors fully appreciate what the flip side of the last year's strong growth might be.
"Most major retailers don't keep their credit card receivables," says Beder, whose firm doesn't have a banking relationship with Target. "You have to ask, are Target people smarter than others? Or are they just willing to carry more risk?"