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Will the CVS Health-Target Deal Actually Help CVS Stock?

While Wall Street didn't wildly cheer the idea, CVS will enjoy the fruits of this deal sooner than later

The CVS Health (CVS) buying spree continues.

Will the CVS Health-Target Deal Actually Help Shareholders? (CVS, TGT)After U.S.-based pharmacy giant CVS Health (formerly CVS Caremark) acquired specialty drug retailer Omnicare (OCR) last month, it quickly moved on to its next target: Target (TGT).

In case you inadvertently missed it, CVS Health just announced a deal with low-cost retailer Target to buy its in-store pharmacies and clinics for $1.9 billion — a move that was mostly shrugged off by CVS stock holders Monday when the news came out.

Naturally, the question CVS stock holders are asking themselves: What does this actually do for me?

What CVS Health Is Up To

CVS Health has two ideas behind this particular deal, but one simple ambition: earnings growth (naturally).

The first part is that CVS Health wants to amass size and scale, because the larger CVS becomes, the greater its bargaining power with pharmaceutical giants like Pfizer (PFE) and Novartis (NVS). Ultimately, that should allow CVS Health to not only maintain its profit margins, but even increase them.

The second part of this: CVS believes that in 2016, the deal will knock off 6 cents per share from the company’s adjusted earnings per share without potential integration costs. In 2017, it expects to return 10 cents in adjusted EPS, and in 2018 and beyond, that figure should be at least 12 cents per share of CVS stock.

In other words, the plan is to pay 6 cents (or a bit more) now to earn a lot more later.

This deal makes more sense when we crunch some raw numbers.

If we take CVS’s annual profit and divide it by the total number of “selling spots” (see report), it makes a net profit of $520,000 per selling spot. CVS Health paid $1.9 billion for roughly 1,700 selling spots in Target stores, or about $1.1 million per spot. If every selling spot in Target eventually sees earnings similar to a CVS Health branch — and it could, as only 11.4% of the company’s revenues come from OTC drugs and general merchandise that it wouldn’t sell within Target locations — then that $1.1 million investment would basically pay for itself within two to three years.

Not bad at all for a deal of such scale.

Investors Not Leaping for Joy

So why aren’t CVS stock holders as enthusiastic for the deal?

Because CVS’s last deal with Omnicare still looms large.

According to the latest reports from the Wall Street Journal, the former attorney general of Louisiana is now investigating whether Omnicare’s board had acted in the best interest of the company. According to the WSJ, the premium paid for the company was just 24% higher than OCR’s average stock price over the past 100 days, so there is a fair chance that this claim may hold water.

With a strong presence in selling prescription drugs to nursing homes and the high-grossing market of medicines for rare diseases, Omnicare’s acquisition is critical for CVS’s business performance. It is part of CVS’s core strategy in targeting the growing middle-age demographic and rare diseases — both are considered the two strongest growth segments of the pharma industry.

Bottom Line

Despite the shadow cast by the Omnicare deal, it would be imprudent for an investor to take CVS stock off the radar. When the Omnicare deal finally clears out, all the best that CVS can offer an investor remains.

And the “best” is substantial — it includes revenue growth, long term value and prospects for improved profitability.

Simply put, CVS is a growth company that’s already on firm footing. If and when the Omnicare matter is settled, CVS stock should be able to run with the wind at its back.

As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.

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