Target Corporation (NYSE:TGT) announced this week that it would sell its network of pharmacies to none other than CVS Caremark (NYSE:CVS). The deal is valued at $1.9 billion and marks an unlikely partnership between two retailers that would otherwise be competitors. Under the terms of the agreement, CVS will rebrand and operate the more than 1,660 pharmacies inside Target stores in addition to transitioning Target's 80 current clinic locations into CVS Health MinuteClinics. The big box and pharmacy chain have also plan to develop 10 new smaller format Target stores over the next two years.
With CVS bent on becoming a full-blown healthcare company and Target looking to reinvigorate its retail business, this tie up is a win-win. However, the real question now is what it means for investors.
Right on target
At the very least, this should give investors renewed confidence in Target's top management, particularly its recently appointed CEO, Brian Cornell. Mr. Cornell, who took the helm last summer, has been saddled with the task of returning the fourth-largest retailer to greatness after a failed expansion attempt into Canada. In addition to the $1.2 billion (after taxes), which Target will make from selling its pharmacy business to CVS, the big box retailer also gets the added bonus of dumping a business that has been a drain on profitability for the company.
Target originally entered the pharmacy business as a way to attract more customers into its stores -- think: one-stop shop. Both customers and investors could get behind that format because it meant added convenience for consumers and increased traffic to Target stores. Fortunately, Target will still benefit from this utility under the new terms with CVS since the pharmacies will continue to run within Target retail locations. The only difference now is that they will be CVS-branded and operated pharmacies.
Investors will also be happy to know that Target plans to use a portion of the proceeds from this deal to repurchase shares thereby creating shareholder value. What's more, the deal should lift Target's gross margins and is expected to be accretive to the stock's earnings-per-share as soon as the deal is officially closed later this year.
There are also significant growth opportunities for CVS Caremark out of this tie-up. For starters, CVS will be able to capture more profits than Target was able to in those locations because of the sheer size and scalability of its existing pharmacy and prescription drugs business. Further, the deal will enable CVS to grow its reach in under penetrated markets such as Seattle, Denver, Portland, and Salt Lake City. It is also worth mentioning that more than 30 million people flock to Target stores each week. This should help CVS add tens of thousands of new customers that otherwise might not have used a CVS pharmacy to fill their prescriptions.
Ultimately, this is a prescription for growth for both companies, and it could also pressure other pharmacy retailers, such as Walgreens, to seek out similar deals. I also think this creates an opportunity for investors to buy and hold shares of Target and CVS today. Target's stock is currently trading around $80 a pop or near the high end of its 52-week range. However, shares look inexpensive with a price-to-earnings growth ratio or PEG of 1.62, which is below the industry average. Meanwhile, shares of CVS also look attractively priced today as they currently boast one of the lowest PEGs in the industry.