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How CVS Plans to Make Target’s Pharmacies Profitable

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Jul. 15 2015, Updated 9:06 a.m. ET

Efficiencies in the retail pharmacy supply chain

CVS Health (CVS) is the largest pharmacy chain in the US in terms of sales and market cap. It accounts for ~21% of the total prescription revenue. As such, it enjoys considerable economies of scale in negotiating terms with suppliers. CVS’ 50–50 joint venture with Cardinal Health (CAH), Red Oak Sourcing, is responsible for negotiating terms with generics suppliers.

Red Oak Sourcing is critical for lowering CVS’ cost of goods sold and in determining efficiencies in its supply chain. More importantly, the company believes there are still more opportunities to generate further economies in purchasing from the Red Oak partnership, according to CVS CEO Larry Merlo.

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Distributorship decision

CVS is planning to transfer Target’s generic business to Red Oak. Target currently sources from McKesson (MCK). However, the company hasn’t made a decision on the sourcing of branded drugs.

During a conference call to analysts on June 15, Merlo noted that “it had a very good relationship” with both McKesson (MCK) and Cardinal Health (CAH). CVS would make “the decision that made the most sense for that business.”

Supply chain impact

The pharmacy purchase from Target, along with CVS’ other acquisitions, should give it scale to cut costs further along the supply chain. CVS also gains additional scale in Seattle, Denver, Salt Lake City, and Phoenix—markets where it doesn’t have a presence yet. The trickle-down effect of lowered costs to patients may further enhance traffic to Target’s pharmacies, benefiting both CVS and TGT. Currently only about 5%–7% of Target’s guests use the pharmacy.

CVS is included in the portfolio holdings of the PowerShares S&P 500 Low Volatility Portfolio ETF (SPLV). SPLV has 20.9% of its holdings invested in consumer staples firms.

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