Target Corporation (NYSE:TGT) is in the midst of a major transformation amid its exit from the Canadian market. Earlier this year, the company unveiled increased cost-cutting plans, including thousands of employee layoffs.
The big-box retailer's latest move to streamline its business came last month, when Target announced that it was selling its network of in-store pharmacies and clinics to none other than CVS Health (NYSE:CVS). The $1.9 billion deal is unique in the sense that it puts two would-be competitors, CVS Health and Target Corporation, on the same team.
As unlikely as this partnership may be, it's a particularly smart deal for Target as the retailer looks to cut underperforming businesses from its operations. Could Target's grocery and food business be destined for a similar fate?
Eat well. Pay less.
Target got into the grocery business in 1995 with the opening of its first SuperTarget location in Omaha, Nebraska. In 2008, the bull's-eye brand rolled out its expanded food format known as PFresh after successfully testing the fresh-food and consumer packaged-goods layout in two of its Minnesota stores. Target now has a full grocery assortment at the vast majority of its stores.
It's true that food and pet supplies is one of Target's fastest-growing business segments today, accounting for 21% of Target's fiscal 2014 revenue. However, groceries and food carry notoriously low margins. In fact, "Grocery is among the thinnest margins out there in retail. The average grocer probably gets a 2%, 2.5%, to 3% percent type operating margin," according to an analyst from Tesley Advisory. It's hardly surprising, then, that Target's grocery business doesn't significantly contribute to the company's bottom line.
Rather, the big-box store's decision to expand into the grocery business was an attempt to position its brand as a one-stop-shop. You see, Target's PFresh offerings help attract more consumers to Target locations on a regular basis, similar to the pharmacies that it recently sold to CVS.
Therefore, if the retailer were to find a grocery chain to rebrand and operate Target's food business, it would be ridding itself of a business that's not earning much profit, while continuing to benefit from the added in-store traffic that offering food and fresh produce affords. A win-win, right?
Keeping its options open
Well, Target seems bent on going it alone in the food category -- at least for now. The discounter has been aggressively expanding its PFresh platform and investing in new better-for-you private labels, including its Archer Farms brand and Simply Balanced food line. "We are not walking away from food, but we certainly want to make sure we put our mark on the food category with items that are uniquely Target, that are right for our guests, that are on-trend," said Brian Cornell, Target's chief executive, to Fortune magazine.
Target's Simply Balanced food collection promises to be a hit with more health-conscious consumers. That's because the brand boasts over 250 food and snack products that are free of artificial flavors, colors and preservatives, and genetically modified ingredients.
Nonetheless, Target's rollout of private labels such as Simply Balanced could inevitably make it more difficult for a buyout deal between Target and an outside grocery company to take place. It isn't likely that Target would sell its Archer Farms and Simply Balanced labels because these tend to carry higher margins for the retailer.
Additionally, Target's decision to bring top talent to its food segment offers yet another reason why the big box chain may not be ready to part ways with its grocery business. In April, Target named veteran grocery top dog, Anne Dament, to the role of senior vice president of merchandising. In a press release, the company said she would be in charge of "leading the strategic repositioning of Target's food business." With Dament leading the charge, Target plans to reposition its approach to food over the next year.
"We have an opportunity to make food more reflective of our brand, elevate the shopping experience and make Target a food destination for our guests," explained Cornell. This tells investors that Target isn't yet ready to outsource its grocery segment even if it is a low-margin business for the retailer.
However, investors should be encouraged by Target's newfound ambition of reinvigorating its food business and thereby making a stronger connection with its customers. Looking ahead, Target says the most critical changes to its food category are set to hit store shelves in 2016, with the expansion of natural, organic, locally grown, and gluten-free options. Bottoms up, bull's-eye fans!
Tamara Rutter owns shares of Target. The Motley Fool recommends CVS Health. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.