The Private Label Credit Card Game

By Will Ashworth | September 01, 2009 AAA

Do you carry a department store credit card in your wallet? Many people do. In fact, it's estimated that 73 million Americans carried them in 2008 and the outstanding balances on those cards total $109 billion. It's big business and although the recession has hurt the industry financially, you shouldn't feel sorry for the banks and retailers that provide these cards. They're still making a mint.

IN PICTURES: Digging Out Of Debt In 8 Steps

Consolidation Wave
In 2001, just eight years ago, 27 private label credit card issuers had receivables over $100 million. Today that number is likely below 10, as consolidation takes hold. Three companies: GE Money, Citi Retail Services and HSBC Retail Services now control 75% of the market with JP Morgan Chase (NYSE:JPM) and Alliance Data Systems (NYSE:ADS) scratching at their heels.

Receivables growth might be slowing at this point but there's still an awful lot of money to be made handling retailers credit card programs. In 2008, General Electric (NYSE:GE) tried to sell its private label credit card operation but didn't find any suitable offers. It's a good thing they didn't. At the end of July the company signed a six-year renewal agreement with Wal-Mart (NYSE:WMT) to operate the world's biggest retailer's private label credit card program. This came weeks after announcing the credit card biz made $252 million in the first half of 2009.

Now, that's less than 1% of GE's $29.98 billion in revenues generated for the first six months of the year but it's a profit nonetheless. (This investment requires keeping an eye on consumer indexes and the overall health of the economy, read Investing In Credit Card Companies.)

Were you aware that until recently, Target (NYSE:TGT) ran a massive credit card operation? Actually, it still does. In the second quarter of 2008, it sold 47% of its credit card receivables to JP Morgan Chase for $3.8 billion. As the economy deteriorated, it became clear the company was better off unloading some of its risk to a third party. That was a wise move. In its second quarter 10-Q, the company revealed that its bad debt expense in the quarter was $296 million, up 64% year over year from $181 million.

More importantly, the bad debts as a percentage of gross receivables went from 8.5% in Q2 2008 to 13.6% this year. That's an incredible jump and the profits fell by the wayside as a result. Its EBIT went from $199 million last year to $65 million in Q2 2009. In terms of EBIT margins, that's a reduction of 2600 basis points in just one year. That's got to hurt. Fear not, Target investors. Its EBIT profit in 2007 was $930 million on $1.89 billion in revenue. It might not get back to those numbers right away, but eventually I can't see why it wouldn't. (Learn more in our Financial Statements Tutorial.)

The Sands Are Shifting
As mentioned, consolidation is gripping the private label credit card business. On August 13, plus-size retailer Charming Shoppes (Nasdaq:CHRS) sold its private label credit card program to Alliance Data Systems for $110 million in cash. Charming Shoppes lowers its debt by $110 million while enabling it to focus on its core retail business, and ADS secures a valuable asset that it can profit from for many years to come. It's a win/win situation.

Retailers like Charming Shoppes are in a precarious position; continue to operate the program independently and it faces the possibility of incurring more bad debts. Sell off the asset and it loses control of a business that indirectly generates $680 million in retail sales.

That's 32% of its total revenue. To ensure it retains those customers, the deal included a ten-year operating agreement between the two parties. Ladies, the Lane Bryant credit card isn't going anywhere.

The Bottom Line
If you invest in retail, you need to keep your eyes open to everything happening in the business, not just same store sales. Credit cards are an integral part of any business and how they use them makes all the difference in the world to both the top and bottom line.

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