CVS Caremark (CVS 1.19%) announced Wednesday that it would become the first major retailer since Target to stop selling tobacco products. The decision will cost the drugstore chain upwards of $2 billion in lost revenue, but it may be the right decision for the company's brand.
If nothing else, CVS' decision got the media's attention. Every major business news website carried the announcement on the front page. Shares of Altria Group (MO 1.09%) and other tobacco giants fell on the news, possibly because Walgreen and other drugstores could feel pressured into following suit. The announcement also puts pressure on Wal-Mart Stores (WMT 0.82%) to consider dropping tobacco products from its offerings.
The uncertainty created by the decision has left many investors wondering what it means for their investment in Altria.
A win for all parties
CVS' primary motivation for dropping tobacco products is that it wants to reposition itself as a health care provider. Chief Executive Larry Merlo said:
Put simply, the sale of tobacco products is inconsistent with our purpose. ... 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.
If CVS wants to associate its brand with good health, it is hard to justify selling cigarettes. The $2 billion in lost revenue from tobacco sales is less than 2% of CVS' $125 billion in sales -- a small price to pay for a huge boost to its brand.
However, Walgreen is probably throwing a party right now, since many of CVS' shoppers may migrate to other drugstores to buy cigarettes, driving foot traffic increases at Walgreen. The market seems to agree that this consumer shift will occur; Walgreen's stock price was up 3.4% on the news and CVS' down 1%.
Even if Walgreen decides that it, too, should stop selling tobacco products, Altria would still not be in trouble. Drugstores account for a mere 3.6% of cigarettes sold in the U.S., and smokers can simply go to gas stations instead of drugstores to buy cigarettes. Given the addictive nature of tobacco, it is unlikely that overall sales volume would decline if the drugstore channel were eliminated.
What about Wal-Mart?
The biggest risk from CVS' decision to stop selling tobacco products is that large retailers like Wal-Mart will feel added pressure to stop selling the products as well. In 2009, then-Vice Chairman Eduardo Castro-Wright said Wal-Mart would consider eliminating tobacco products from its stores.
Like CVS, Wal-Mart is increasingly involved in directly providing health care services to customers. Wal-Mart has retail clinics in many of its stores that provide a cheaper alternative to general practitioners. Retail clinics and cigarette sales seem like an odd combination under one roof. Then again, The Atlantic points out that Wal-Mart also sells guns while providing treatments for wounds, and alcohol while providing treatments for liver disease.
It is no surprise that Wal-Mart would consider removing items harmful to consumers' health when it also provides health care services. However, there is reason to believe the company will not follow in CVS' footsteps. Chief Executive Scott Lee invoked shareholder value when defending the company's tobacco sales: "There are still a tremendous number of our customers who smoke. We've got a market to serve, and second we've got shareholders to think about."
No reason for worry
The Wall Street Journal reports that 84.5% of cigarettes are purchased at gas stations, specialty tobacco stores, and convenience stores, meaning no more than 15.5% are sold through drugstores and big-box retailers. Gas stations, tobacco stores, and convenience stores depend on tobacco sales to drive foot traffic, so those channels would never abandon tobacco products. As a result, Altria's products should still have wide distribution even if Wal-Mart and other retailers were to drop its products.
So, it seems, the market has overreacted to CVS' announcement; Altria is hardly affected by its decision.