Nov. 20 (Bloomberg) -- Target Corp., the second-largest U.S. discount chain, posted an unexpected decline in quarterly profit after consumers facing higher mortgage payments and gasoline costs cut spending.

The retailer also said today it will buy as much as $10 billion of its stock, which lost 26 percent of its value since reaching a record in July. The shares fell 4.1 percent.

Target reduced sales forecasts in September and October after unseasonable weather led consumers to forsake sweaters, coats and fleece. J.C. Penney Co., Kohl's Corp. and Lowe's Cos. lowered their profit predictions for the holidays in the past week as customers grappled with the worst housing slump in 16 years.

``It's turned out they're a bit more dependent on the housing market than investors initially thought,'' said David Abella, an analyst at Rochdale Investment Management in New York, with $2.5 billion in assets including Target shares. ``I don't think any retailers yet see the light at the end of the tunnel.''

Target expects a ``decent'' holiday season, although demand for clothing and home goods will remain ``under more pressure'' at least through the first quarter of next year, President Gregg Steinhafel said during the company's earnings call today.

Third-quarter net income fell 4.4 percent to $483 million, or 56 cents a share, from $506 million, or 59 cents, a year earlier, Minneapolis-based Target said in a statement. Analysts estimated average profit of 62 cents a share.

Target decreased $2.21 to $51.69 at 4:32 p.m. in New York Stock Exchange composite trading. The shares fell 9.4 percent this year, compared with a 1.5 percent decline at Wal-Mart Stores Inc. and a 46 percent drop at J.C. Penney.

`Decent' Holidays

Revenue, which includes credit-card payments, climbed 9.3 percent to $14.8 billion. Sales of more profitable clothing and home goods were ``soft,'' Target said.

The retailer forecast sales at stores open at least a year to rise 3 percent to 5 percent in the current quarter. Same- store sales gained 3.7 percent in the third quarter, Target reported last week.

Investors say declining home values may hurt many of the retailer's core customers: young shoppers who are furnishing their own homes and can no longer count on borrowing against their equity. Others face increases in the monthly payments from adjustable-rate mortgages.

Gross margin, or the profit left after subtracting the cost of goods sold, narrowed to 31.87 percent of sales from 32.42 percent.

Home Goods

While clothing and home goods accounted for 41 percent of Target's sales last year, the retailer derives more than 80 percent of its profit from those categories, Virginia Genereux, an analyst at Merrill Lynch & Co., wrote in a Nov. 14 note. She recommends investors hold their shares.

Clothing and home goods accounted for 15 percent of sales at Wal-Mart last year.

Target, under pressure from activist investor William Ackman to raise its share price, said in September it would examine whether to sell its $7 billion credit-card portfolio and boost share buybacks.

The company says it plans to make a decision by the end of December.

``We would of course look at an array of financing alternatives relative to the status quo,'' Chief Financial Officer Douglas Scovanner said. ``But the status quo has proved to be a very effective method of funding that portfolio in the past.''

Debt Funding

Target said today it would use debt to fund part of the repurchase, which is more than one-fifth of the shares outstanding based on today's stock price.

``It's the right thing to do to leverage up their balance sheet and buy back stock in the face of slowing overall sales growth,'' said Jeffrey Klinefelter, an analyst at Piper Jaffray Cos. in Minneapolis, who recommends investors hold their shares.

Ackman didn't respond to an e-mail seeking comment.

Wal-Mart, the world's largest retailer, said last week that third-quarter net income rose to $2.86 billion, exceeding analysts' estimates, after it cut expenses and lured shoppers with earlier and more numerous discounts.

Target has attracted shoppers with clothing and home goods by designers such as Isaac Mizrahi. Yesterday the retailer said it will introduce its own line of clothing and shoes by Nike Inc.'s Converse unit next year.

Target is also testing the sale of returned and refurbished consumer electronics on its Web site, Steinhafel said during the call today. Target hasn't made a decision whether to continue the ``tiny'' program, although it has been successful, he said.

To contact the reporters on this story: Lauren Coleman-Lochner in New York at llochner@bloomberg.net.

Last Updated: November 20, 2007 17:23 EST