Wal-Mart's Holiday Wish

But Target says it will meet the price-cut challenge.
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Updated from 2:53 p.m. EST

Wal-Mart

(WMT) - Get Report

continues to be overshadowed by its trendier rival

Target

(TGT) - Get Report

, but the world's biggest retailer is banking on holiday promotions to help it regain the edge in discount shopping.

The two retail giants posted contrasting third-quarter results Tuesday, as Wal-Mart was hurt by sluggish sales and Target continued to attract more fashion-minded upper-scale customers.

Wal-Mart earned $2.59 billion, or 62 cents a share, from continuing operations for the quarter ended Oct. 31, up from the year-ago $2.42 billion, or 58 cents a share. The latest quarter included a penny a share in gains tied to property insurance.

Sales rose 12% from a year ago to $83.54 billion, as sales rose 7.8% at U.S. Wal-Mart stores, 1.9% at Sam's Club stores and 34% internationally. Analysts surveyed by Thomson First Call were looking for earnings of 60 cents a share on sales of $84.48 billion.

U.S. same-store sales increased 1.5%, reflecting a 1.5% increase for Wal-Mart Stores and a 1.8% increase for Sam's Club, excluding the impact of fuel.

Wal-Mart CEO Lee Scott noted while U.S. sales were softer than the company had hoped, he said there are there are real opportunities in the fourth quarter to build on the momentum of its aggressive pricing strategy.

The company has already begun launching discounts on goods like electronics and appliances to keep rivals like Target at bay. On Tuesday, Wal-Mart announced further price cuts to toys and games, bringing its running total on toy rollbacks to 150 products.

"This season, no one will doubt Wal-Mart's leadership on price and value," Scott said in a statement.

During its conference call, Target executives said they were ready to meet Wal-Mart's challenge.

"Wal-Mart takes a very aggressive stand in small appliances, toys, and electronics, and we respond aggressively," said President Gregg Steinhafel. "As we get deeper into the holiday season, we expect to see more price-cutting and we will respond as quickly as we can to make sure our prices are in line."

Target reported a 16% rise in third-quarter profits, beating Wall Street's expectation, as the Minneapolis-based discount retailer continued to see healthy same-store sales growth.

The company earned $506 million, or 59 cents a share, up from $435 million, or 49 cents a share, a year earlier. The results beat Wall Street's estimate for earnings of 55 cents a share. Target's total revenue climbed to $13.57 billion from $12.2 billion, driven by the contribution from new store expansion, a 4.6% increase in same-store sales and the contribution the company's credit card operations.

Target said it expects full-year earnings of $3.17 a share, above Wall Street's expectation of $3.13.

"Target has been out-comping Wal-Mart," says Ken Perkins, president of research firm Retail Metrics. "They have a smaller base, but they are still clicking on all cylinders. They're able to attract the higher-end consumers that Wal-Mart is struggling to get."

Target has had success in marketing itself as a trendy alternative to the usual dowdy image that comes with discount shopping. The company has brought in high-fashion designers to add pizzazz to its clothing line, along with noted designers for home goods and furnishings.

Wal-Mart, meanwhile, has packed its apparel shelves with more private-label and fashion-oriented clothes, but that effort appears to have not yet paid off.

While Wal-Mart is betting that its holiday rollbacks will drive customers to its stores, it could come at the expense of margins. The company didn't have any major discounts in the third quarter, Perkins notes, and its margins improved in all three segments during the period.

"This

holiday discounting should drive some traffic into the stores," Perkins says. "The margins are going to be lower, but they're hoping that if you come in to buy a flat-screen TV, you'll also shop in the rest of the store for the sort of times they may be selling at a higher margin."

Meanwhile, Richard Hastings, retail sector analyst at Smyth-Bernard Sands, noted that both Wal-Mart and Target are dependent on areas other than their core business. In the case of Wal-Mart, Hastings said the company relies upon its international growth and its supermarket business. Target, on the other hand, he said, depends very much on its credit card revenue, which Hastings said grew significantly in the third quarter.

"Take that out and per-store productivity was relatively flat," he says.

During the conference call, Target CFO Doug Scovanner said the company believed a rise in delinquencies and write-offs had likely reached or were near their peak.

"We expect the sharp growth in fourth-quarter profitability to be dominated by our core retail operations," he said.

Shares of Wal-Mart recently were trading were up $1.36, or 2.9%, to $47.68, while Target was climbing $1.28, or 2.2%, to $59.04.