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As reported in the most recent quarter's earnings report, CVS Caremark Corp. (NYSE:CVS) presently owns 7,665 locations, all inclusive of retail drugstores and onsite/offsite pharmacies. The company is spread across 45 states in the US, the District of Columbia, Puerto Rico, and Brazil. With a number of patents expiring and the imposition of new laws, pharmaceutical chains are forced to change their business strategies in order to continue to remain in strong competitive positions. I will now elaborate CVS' struggle to beat competitors through its proactive approach and the long-term prospects of the company.

Say No to Tobacco

The company recently announced that it will quit selling tobacco products from October onwards. The stock closed at a lower price following the news as opposed to the previous day's closing, marking an immediate decline of more than 100 basis points. An early estimate indicates that the company's revenues will dip by approximately $2 billion per year as a function of kicking out tobacco products; that makes up about 2% of its per share earnings. Analysts were expecting the company to generate $133 billion in revenue by the end of this year. Tobacco sales were responsible for drawing 17 cents per share on an annual basis up until now. Letting go of that chunk of revenue is a big step for the company, especially when no other competitor has considered eliminating tobacco products from their shelves. It appears as though CVS is giving away money to its competitors. In the short term, the revenues and profits of the company's competitors will trend higher compared to CVS, which is precisely why their prices in the stock market leveled up following the news. Considering CVS as an immediate sell, investors switched their investments to its competitors Walgreen (NYSE:WAG) and Rite Aid Corp. (NYSE:RAD). As a result, Rite Aid's price increased by 2.64% and Walgreen by 3.40%.

My Take

In my honest opinion, it is a rather proactive approach to drop tobacco from its pharmacies. Considering that CVS is on course to lose about a couple billion dollars annually as a function of this move, it is a big decision for the company to permanently put a stop to that revenue generator. Letting go of tobacco products is expected to benefit the company in a number of ways:

  1. It will further narrow down the focus of the company as a healthcare provider.
  2. By removing tobacco from the shelves, the image of the company will improve in the eyes of insurers, hospitals, customers, and physicians. The move has already been given thumbs up by the American Medical Association [AMA] and by President Barack Obama himself and other government officials.
  3. The company has permanently removed a product line that was already showing declining margins, thus saving itself from incurring losses.

In addition to that, pharmaceutical companies are forced to change their approach towards business in the wake of expiring patents and a slump of prescription drug sales. Since the company said goodbye to tobacco products, it will definitely streamline the operations of the company by making it more focused on the health industry. Furthermore, pharmacies have been criticized for selling tobacco products in their stores for a long time. It does not suit a healthcare provider's goals to sell tobacco that is responsible for about 480,000 deaths per year in the US. CVS' initiative will be interpreted as a responsible act, and this will translate into a higher customer retention rate compared to its competitors in the long term. Therefore, the company's popularity as a managed healthcare provider will eventually turn into higher profit margins in the future.

From the insurers' perspective, CVS is becoming increasingly reliable as a low cost yet effective healthcare provider. Millions of uninsured people are expected to be issued insurance plans in the near future as part of the Affordable Care Act (Obamacare). In order to alleviate emergency room costs, the insurers are likely to sign up with CVS to provide care for minor diseases given its enhanced brand image. This will facilitate the company's ability to form alliances with hospitals as well giving it an edge over other competitors. Discontinuing the cigarette sales is good for the company from a financial standpoint as well. The US Centers of Disease Control and Prevention [CDC] reports that the number of smokers in the US is remarkably down from historical highs; only about 18% of the US population is comprised of smokers compared to 42% in 1965. US cigarette-sales dropped by approximately 4% in 2013 alone. Thus, eliminating a decelerating product line before it starts incurring losses is a rather preemptive approach.

Final Take

In view of all these facts, it is quite likely that the company will perform better than its competitors in the long term. It has not yet been disclosed by the company, but CVS is already working on a few projects and partnerships to strengthen its position against its competitors. I believe that the recent drop in price is an irrational sentiment on the part of investors. The company's revenues are likely to surge in the future as insurers and hospitals partner with the company, and this will lead to a price appreciation yet again. We should instead view the dip in price as a buying opportunity.

Source: CVS: Bright Long-Term Prospects