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Sale of Target Pharmacies to CVS Marks a Strategic Retail Shift

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Prioritization at Target

Target’s (TGT) sales and profitability have been affected in recent years, firstly due to its data breach and secondly due to its exit from Canada. Operating margins for the retailer (XRT) have declined for three straight years. The CVS transaction will be immediately accretive to Target’s profitability and earnings per share (or EPS), as explained in Part 2 of this series.

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Use of sale proceeds

Target expects to use the sale proceeds to finance share buybacks, as well as to invest in its digital capabilities and in small format stores like City Target and TargetExpress. During its 1Q16 earnings call, Target mentioned a focus on signature categories, such as style, baby, children, and wellness.

The company is bullish on its prospects for these areas, which is justified by its recent performance. Kathee Tesija, Target Corporation’s chief merchandising and supply chain officer until July 6, reported 5% comps for its beauty category in 1Q16, as well as a sell-out of 90% of its recently introduced Lilly Pulitzer line of apparel the first day in stores.

Digital thrust

The Target–CVS deal has major implications for omni-channel retail. A bigger store network should boost CVS in its multichannel efforts, particularly in the pick-up of prescriptions. This is essential, as rival chains ramp up either organically or inorganically.

Target is also looking to invest part of the sale proceeds in digital investments. Target’s e-commerce sales grew 30% year-over-year to ~$3 billion in the last fiscal year. In 1Q16, e-commerce sales grew ~38% year-over-year.

E-commerce is an important growth driver for consumer staples (XLP) retailers Walmart (WMT) and Costco (COST) as well.

  • Walmart reported ~21.2% growth in web sales to $12.2 billion in fiscal 2015.
  • Costco saw e-commerce sales rise 18% to almost $3 billion in fiscal 2014.[1. Internet Retailer estimates]

Wellness focus

Target is looking at wellness as a key growth driver that will also complement the CVS pharmacies. It launched its Made to Matter—Handpicked by Target collection in April 2014. The collection features 17 brands with a health and wellness focus, including Chobani, Kashi, and Annie’s Homegrown. While some of these brands were already available at Target, each brand is making available some products that are exclusive to Target. The company reported that the collection is on track to ring up sales of $1 billion this fiscal year.

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