CVS Stops Cigarette Sales; What It Means For Investors

| About: CVS Health (CVS)

CVS/Caremark (NYSE:CVS) announced today that it will no longer be selling cigarettes and other tobacco products at any of its U.S. locations beginning Oct. 1, 2014. This step will make CVS the first national pharmacy chain to take such a strong position in support of the health and well-being of its patients and customers.

CVS' chief medical officer added the following comments:

CVS Caremark is continually looking for ways to promote health and reduce the burden of disease...Stopping the sale of cigarettes and tobacco will make a significant difference in reducing the chronic illnesses associated with tobacco use.

Impact on CVS/Caremark

The move will cost CVS approximately $2 billion in lost annual revenue from tobacco sales, as well as other products purchased by the same shoppers, according to management's estimates. This should result in a $0.06 - $0.09 per share impact on EPS for 2014.

Considering the company generates approximately $125 billion in total annual revenue, the impact for shareholders will likely be minimal, and company guidance for segment operating profit and 2014 EPS estimates remain unchanged.

Furthermore, the company said in its statement that it has "identified incremental opportunities that are expected to offset the profitability impact", but did not provide any more details.

One likely area is its contracting with hospitals and health plans. The Washington Post notes that CVS has between 30 to 40 partnerships with health care systems across the country, and continues to explore additional partnership opportunities.

CEO & President, Larry Merlo echoed the sentiment that this move would help differentiate CVS in the eyes of both consumers and health plans:

As the delivery of health care evolves with an emphasis on better health outcomes, reducing chronic disease and controlling costs, CVS Caremark is playing an expanded role in providing care through our pharmacists and nurse practitioners. The significant action we're taking today by removing tobacco products from our retail shelves further distinguishes us in how we are serving our patients, clients and health care providers and better positions us for continued growth in the evolving health care marketplace.

Competitors' Impact & Response

CVS is one of the three largest retail pharmacy chains in the U.S., the other two being Walgreen (WAG) and Rite Aid (NYSE:RAD). Rite Aid is still in the middle of a (potentially successful) turnaround, and will not likely respond to this move by CVS in the short-term.

On the other hand, Walgreen has already put out a statement in response to CVS' announcement, saying "we will continue to evaluate the choice of products our customers want".

Walgreen is also trying to expand the role of its pharmacists by offering more comprehensive services. However, they have chosen to vertically integrate in a different way from CVS, by divesting its PBM business and focusing on creating greater drug purchasing power through recent acquisitions and alliances, including Alliance Boots (in Europe) and AmerisourceBergen (in the U.S). By reducing its cost to acquire drugs, Walgreen is trying to maintain its margins against declining reimbursement pressure from PBMs and health plans.

In addition, Walgreen is focused on increasing sales per sq. ft. in its stores through its front-end, or non-prescription, products. Therefore, it may be difficult for Walgreen to make a similar move as CVS did, if it means sacrificing foot traffic and front-end sales.

However, all three chains have reward programs and extensive "big-data" back end programs, which should help them evaluate the purchasing patterns of shoppers and the likely impact of eliminating tobacco sales.

So it should be easy enough for Walgreens' management team to determine if this would have a similarly minimal impact on their sales and growth prospects as with CVS.

The Bottom Line

Overall, this seems to be a smart move on CVS' part. It will have minimal impact on revenue and earnings, and fits the company's strategic plan to evolve from a traditional pharmacy role to a more comprehensive, integrated provider of healthcare. Additionally, it wins the company positive press (including comments from President Obama) and helps to differentiate itself from its competitors.

In the long run though, I do not believe this will give CVS a lasting competitive advantage over its peers. If profits exist in the disease management space or in other contracting opportunities with health plans and providers, Walgreen and Rite Aid will eventually adapt in order to capture some market share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients.