Target Seeking Higher Traffic & Business Consolidation With CVS Deal

In an interesting turn of events, Target (NYSE:TGT) has signed a definitive agreement to sell its pharmacy and clinic business to the drugstore chain CVS Health (NYSE:CVS) in a $1.9 billion deal. Under the terms of the agreement, CVS will rebrand and operate over 1,600 pharmacies located within Target’s stores across 47 states. Also, CVS will add a “CVS/pharmacy” outlet to all new Target stores offering pharmacy services. Target’s 80 clinics will be rebranded as MinuteClinic and CVS will take this count to 100 within three years post the closure of the deal. Moreover, the two companies will work together to develop a slightly updated format of Target Express that will include a CVS/pharmacy. Target expects to open about 10 such stores in two years after the deal has been closed. The timing of the closure remains uncertain but it can be completed by the end of the year. The deal, post closure, is expected to be accretive to Target’s EPS and will provide it with some capital to invest in its long-term growth strategies. ^[1]

While this agreement is inline with CVS’s plans to increase its clinic count to 1,500 by 2017, Target will benefit in terms of store traffic as well as freed up resources. Letting an expert provide healthcare within its stores can help Target bring in additional traffic. Moreover, the deal liberates the retailer’s resources for its fashion business, which has been its prime focus of several quarters now. Target was once known for its affordable fashion and home related merchandise, but with its aggressive focus on groceries, the company lost this focus over the last few years.  The retailer now aims to restore these strategies under the leadership of its new CEO. The pharmacy business deal is clearly indicative of this aim.  In addition, the deal lead to higher store traffic on account of CVS’s strong market footing. Moreover, CVS will be able to leverage its purchasing power and size in sourcing pharmaceuticals to these in-store locations.

Our price estimate for Target stands at $78, which is just below the current market price.

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Target has been fighting hard to win back its customers after the infamous data breach of 2013. When the new CEO Brian Cornell took over the company last year, he explicitly mentioned that he wants to elevate the focus on the company’s signature categories, in order to bring customers back. So far, it has worked well for Target as its comparable sales have improved, driven by higher store traffic. The most recent move of handing over its pharmacy business to CVS is another step towards augmenting store traffic. CVS has a strong reputation in the market and its outlets inside Target stores can help the retailer attract additional customers and earn incremental revenues through cross selling.

Under the new CEO, Target has also looked to consolidate its business to focus only on the most promising aspects. It ended its loss making Canadian operations earlier this year to divert its focus and resources to the U.S. business. Within the U.S. segment, it laid a greater emphasis on fashion and home, categories which once made a name for Target in the U.S. retail industry. Now, it has sold off the pharmacy business, which works in more ways than one.

Pharmacy sales are a small business for Target, though its precise size was excluded from the announcement. The deal values the business at $1.9 billion, which is about 4% of the company’s current market value. For reporting purposes, Target includes pharmacy in its household essentials category, which also includes personal care, baby care, cleaning and paper products, and accounts for about 25% of the company’s revenues. ^[2] Even if the sub-segments of the household essentials category contribute proportionally to revenues, pharmacy’s contribution  to revenues and value (assuming margins across the categories are same) is likely less than 5%. Looking at these figures, it is safe to say that the absence of the business and the corresponding cash will keep Target’s value steady, but it has a lot to gain from customers who will walk into its stores to visit CVS/pharmacies.

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1. CVS Health and Target Sign Agreement for CVS Health to Acquire, Rebrand and Operate Target’s Pharmacies and Clinics, Target, Jun 15 2015 [↩]
2. Target’s SEC filings [↩]