Healthy First: CVS Will Stop Selling Cigarettes

Pharmacy giant CVS Caremark  (NYSE: CVS  )  announced Wednesday that it will stop selling cigarettes and tobacco products at its 7,600 stores in the U.S. by October.  Will the move set a trend in the health care industry? How should investors play this? 

Healthy choice
In addition to gaining some goodwill among health advocates, the move by CVS indicates that the company wants to grow by promoting healthy habits and the needs of the majority of its customers, including corporations and government agencies. CVS will most likely focus on its prescription drug business and administering managed pharmacy benefits programs instead of selling something which is known to cause myriad (and expensive) medical issues. The prescription drug segment generates over two-thirds of its overall revenues. Retail merchandise, which includes cigarettes, only comprise 15% of sales.

CVS will have to make up for lost revenue, estimated to be around $2 billion annually. Total corporate revenue was $123 billion in 2012. However, since the consumption of tobacco products is on a downward spiral in this country it may not affect the company that much over the long term. As far as the short term is concerned CVS stated that the impact on EPS will be six to nine cents per share this year, a relatively minor hit. Investors shouldn't worry. 

Trend setting?
What are the other pharmacy companies doing?

At Walgreens (NYSE: WAL  ) , prescription drug sales generated about 63% of sales for fiscal 2013, while general merchandise represented 27% of sales.  Will the company give up a chunk of its revenues to follow suit? Early indications are that Walgreens has no immediate plans to stop selling cigarettes, so it might get some backlash from the same advocates that are praising CVS.

It might be too early to judge the impact to investors, which probably would take a long time to materialize. Walgreens continues to grow though acquisitions and new stores, notably the acquisition of Kerr Drug's retail drugstores in late 2013. The company has a low long term debt to equity level of 0.22 and a reasonable 41% payout ratio so expect the regular dividend increases and share buybacks to continue.

Rite Aid (NYSE: RAD  ) also has no plans to discontinue cigarette sales. For the most recent quarter, slight growth in revenues ($6.4 billion from $6.2 billion in the year-ago quarter) were balanced by a decline in earnings to $0.04 per share from $0.07 in the year-ago quarter.. Rite Aide won't want to rock the already rickety boat by getting rid of tobbaco. There doesn't appear to be any incentive for Rite Aid to follow the lead of CVS either unless anti-smoking advocates ratchet up the pressure or management views the potential good press as worth the potential loss of revenue. Investors can probably expect much of the same performance --- not all that great --- going forward. 

Foolish conclusion
CVS appears to be implementing a "health first" business model by removing cigarettes and other tobacco products from its shelves. Good move. Gain some goodwill with advocates and important customers to help grow a critical segment of its business. Investors might benefit in the long run. 

Other drug store chains like Walgreens and Rite Aid appear not to be following suit. Their investors may expect much of the same performance in the future.

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9/30/2014 2:17 PM
CVS $79.64 Down -0.39 -0.49%
CVS Health CAPS Rating: ****
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Rite Aid Corp CAPS Rating: **
WAL $24.00 Down -0.04 -0.17%
Western Alliance B… CAPS Rating: ****

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