Yahoo Finance How the CVS–Target Deal Trims the Fat
Why Target’s Pharmacies Sale to CVS is an Industry Game-Changer
CVS Health’s supply chain efficiencies enhance Target’s profitability
As mentioned in the last article, CVS Health (CVS) hopes to apply the same purchasing economies arising from Red Oak Sourcing after acquiring Target’s (TGT) pharmacies. There is considerable slack apparent in Target’s pharmacy business.
CVS’ retail pharmacy segment earned an operating income margin of almost 10% in 2014 on sales of $67.8 billion. Target reported zero operating profits for its pharmacy business for the last fiscal year, with a turnover of $4.2 billion.
Margins impact
According to Target CFO John Mulligan, the cost of goods sold came in at ~$3.2 billion for the company’s pharmacy business in the last fiscal year. This would work out to a gross margin rate of 23.8%, compared with 31.8% for CVS’ retail pharmacy segment in 2014.
Margins for Target’s pharmacy business may also benefit from CVS’ Generic Dispensing Rate (or GDR), one of the best in the industry. CVS reported a GDR of 83.1% in 2014, up from 79.2% in 2012. In comparison, Walgreens Boots Alliance has a GDR of 77.6%. As mentioned earlier, generic prescriptions are more profitable for pharmacies, compared with brand-name drugs.
However, the resultant upside in Target’s pharmacy margins may be tempered somewhat. One of the reasons is that CVS recognizes revenue from specialty prescriptions under its PBM (Pharmacy Benefit Manager) segment. Specialty prescriptions have comparatively lower margins. Diplomat Pharmacy (DPLO), which is a specialty pharmacy operator, posted a gross margin of 6.3% in its trailing 12 months.
As mentioned earlier in the series, the revenue upside for Target’s pharmacy business is likely to result from higher store traffic, leading to more transactions and number of scripts. It is also likely to benefit from CVS’ higher profitability metrics, which lead its industry peers. We’ll discuss this in the next article.
CVS, WBA, and TGT are included in the portfolio holdings of the iShares S&P 100 ETF (OEF). OEF has 10.7% of its holdings invested in consumer staples firms and 11.4% of its holdings invested in consumer discretionary firms. They are also a part of the Vanguard S&P 500 ETF (VOO). VOO has 9.5% of its holdings invested in consumer staples firms and 12.5% of its holdings invested in consumer discretionary firms.
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