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Rising Prices Take Aim at Target's Bullseye

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Someone issue an alert to all Target (NYSE: TGT  ) security guards: Rising prices have it out for the retail and food giant, and they could strike at any moment. Actually, scratch that memo; it seems rising prices have already done their dirty work as is evidenced by yesterday's quarterly report.

Off the mark
Just when we thought that we were done with the excuse that rising food and gasoline costs are eating into bottom-line profits, we're dragged back into the reality of $100 oil and food costs at multi-decade highs. Target's quarterly numbers reflected the struggle of this retail powerhouse against rapidly rising input costs.

For the quarter, the company reported a modest 2.2% rise in revenue, to $15.9 billion, and net income was up 2.7%. The company managed to turn that into a 10% jump in per-share profits, to $0.99, from the year-ago period. Although profits sailed past the consensus expectations of $0.94, revenue missed by the mark by roughly $85 million.

Investors responded by promptly browbeating Target's stock to within an inch of its 52-week low on the mixed results. But might investors have jumped the gun and missed the bullish keynotes of this report? I think so...

Calling all Robin Hoods
The most bullish aspect of Target's report was the health of its credit card division, which is also owned in part by JPMorgan Chase (NYSE: JPM  ) . Despite witnessing an 18.3% tumble in credit card revenue, profits in the U.S. credit segment jumped dramatically from $111 million in the year-ago period to $194 million. Why the jump? The credit quality of Target's customer base is improving. Bad debt expense dropped to a mere $12 million this past quarter from a whopping $197 million last year.

Also, don't discount the effect that store reward cards have on Target's consumer base. The company's total credit card penetration rose 1.5 percentage points to 5.9%, while its REDcard penetration jumped from 4.9% to 7.6% year-over-year. This is important for three reasons:

First, the more that consumers are using a Target credit card, the fewer fees that Target is paying to Visa (NYSE: V  ) , Mastercard (NYSE: MA  ) and American Express (NYSE: AXP  ) for use of their third-party cards. Secondly, rewards cards generate loyal customers and make it less likely that consumers will opt to shop at rivals Wal-Mart (NYSE: WMT  ) or Costco (Nasdaq: COST  ) . Finally, reward cards track shoppers' spending habits, making it much more likely that Target is going to have the right mix of product for its customers and decreasing the likelihood of an inventory glut.

Target's bullseye
Input costs may be rising, but Target looks well-positioned going forward. The credit quality of its customers is improving, and its rewards program penetration has taken off. In a land of razor-thin margins, Target appears to have the pizzazz to grow its business considerably quicker than the likes of Wal-Mart and Costco. It may be time to add Target to my own watchlist now that the company's PEG ratio is hovering around 1 and its forward P/E has drifted below 11.

Does Target deserve a spot on your watchlist or in your portfolio? Sound off in the comments section below and consider tracking Target, and its closest rivals Wal-Mart, and Costco with the free and easy-to-use My Watchlist.

The Fool owns shares of Wal-Mart, Costco, and JPMorgan Chase. Motley Fool newsletter services have recommended Wal-Mart, Costco, and Visa, as well as a diagonal call position on Wal-Mart.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's free of charge and requires no coupons.

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