CVS: Betting On Health Is Good For Business

Sep. 5.14 | About: CVS Health (CVS)

Summary

CVS removed tobacco products from its stores, risking a loss in the $2 billion in revenue those products generated.

But the move is a strategic one. It allows CVS more aggressively focus on expanding its role as a healthcare provider.

CVS is taking a risk but the company is fundamentally strong and should generate strong returns going forward, even without tobacco.

CVS (CVS) reached a new 52-week high of $81.16 Thursday after the retail pharmacy chain changed its name to CVS Health from CVS Caremark Wednesday and formally announced that it would stop selling tobacco products effective immediately.

CVS currently operates 7,700 drugstores and 900 walk-in clinics. The company also operates as a pharmacy-benefits manager for almost 65 million members. By removing tobacco products, CVS is able to push towards "becoming a provider of care and having in-store pharmacists and nurse practitioners offer high-quality care in a low-cost environment," says Leerink Partners analyst David Larsen. CVS is "expanding on the basis of in-store clinics, deeper relationships with health plan customers and integrated health systems around the country."

INVESTMENT THESIS

There is certainly a loss of revenue from the move to discontinue selling tobacco products - as much as $2 billion - but CVS doesn't seem worried. Moreover, it seems as though the company is robust enough to handle any dip in revenue. CVS has enjoyed strong sales growth while effective management of operating costs has helped the company's earnings increase year over year. CVS is a good company and should continue its climb.

REMOVING TOBACCO PRODUCTS

According to the Wall Street Journal, ridding its stores of tobacco products means that CVS is forgoing around $2 billion in annual sales. "While there's never a right time to walk away from $2 billion in revenue, this was the right time," CVS President and Chief Executive Larry Merlo said in an interview. "Eliminating this obstacle will allow our company to grow over the long term."

"The financial risk was balanced by the hope that being the first major pharmacy chain to stop selling tobacco would create a public relations halo," explains The Wall Street Journal. "CVS is banking that the distinction can help it win business in other parts of the company, like administering prescription-drug programs for clients, and position it as a broader provider of basic health services."

While it is difficult to say whether CVS will be successful in replacing the revenue it had enjoyed from tobacco sales with improved sales in other areas, one thing that is clear is that CVS is strong enough to weather the risk.

FUNDAMENTALLY STRONG

CVS has enjoyed strong sales growth year over year. Its net revenues increased by 3% from 2012 to 2013, moving to $126.76 billion at the end of fiscal 2013 from $123.12 billion at the end of fiscal 2012. Looking at the company's most recent quarter, CVS had a quarterly revenue growth of 11% year over year, versus an industry average of 4.6%.

Moreover, the company's operating profits and earnings saw even greater gains year over year CVS operating profit moved to $8.04 billion at the end of fiscal 2013 from $7.21 billion at the end of fiscal 2012 - an improvement of 11.5% - and its earnings saw even greater gains year over year. CVS posted a diluted earnings per share of $3.75 for fiscal 2013, up from a diluted EPS of $3.02 for fiscal 2012 - an increase of 24% - and those gains are expected to continue. Consensus estimates put CVS's earnings per share at $4.49 for 2014, moving to $5.06 for 2015 - an increase of roughly 12.7%

In addition, for all this expected growth, CVS is priced low. The company's forward price to earnings ratio is less than 16 looking forward to the fiscal year ending 2015. In comparison, rival Walgreen Co. (WAG) is priced at 17 times its forward earnings (fye Aug 31, 2015), its quarterly revenue growth is at just 6% year over year for the recent quarter and its earnings per share is expected to come in at $3.31 for FY2014 moving to $3.66 for FY2015 - an increase of 10.6%.

There could be some debt issues in the short term - CVS has a quick ratio of 0.68 - but the company enjoys a low debt to equity ratio of 0.35, which is below its industry's average.

TAKEAWAY

CVS is robust and has shown good management of costs. In turn, this has resulted in good earnings growth. The company is taking a gamble on removing tobacco products from its stores, but CVS is strong enough to risk losing those sales - and its strategic initiatives are promising. Look to CVS for continued growth in the long term.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.