Source: CVS Caremark.

CVS Caremark (CVS -1.62%) reported earnings for the fourth quarter of 2013 on Tuesday. The numbers were better than expected, and the company raised earnings guidance for the first quarter of 2014. The decision to exit the tobacco business is looking like a smart move in terms of costs versus benefits, and CVS is well positioned for growth in the years ahead.

The numbers
Sales during the quarter increased by 4.6% to $32.8 billion versus $31.4 billion in the same quarter of the prior year; this was above analysts' expectations of $32.6 billion. Revenues in the pharmacy services segment grew by 5.2% to $19.6 billion, while the pharmacy retail division produced a sales increase of 5.6% to $17.2 billion.

Retail pharmacy same-store sales increased 4% over the prior year, with pharmacy same-store sales up 6.8% and front-end same-store sales down 1.9%. The decline in front-end same-store sales was produced by softer traffic, which was partially offset by an increase in basket size.

Income from continuing operations increased 12.4% to $1.3 billion during the quarter. Adjusted earnings per share came in at $1.12, a 15.8% increase versus the fourth quarter in the previous year and beating analysts' estimations by a penny.

The company reaffirmed its earnings guidance for 2014 in the range of $4.36 to $4.50 per share. But CVS raised its guidance for free cash flow during the year to a range of $5.5 billion-$5.8 billion from $5.1 billion-$5.4 billion, and cash flow from operations guidance was increased to between $7.0 billion and $7.3 billion versus a previous guidance of $6.6 billion-$6.9 billion.

Management also raised earnings-per-share guidance for the first quarter of 2014 to between $1.03 and $1.06 versus $0.97 to $1 in the prior estimate. The new guidance is above analysts' estimates for the quarter, currently at $1 per share on average.

A healthy future
The fact that CVS reported strong performance and raised its forward-looking guidance is quite reassuring, especially now that the company could lose some market share in front-end sales after deciding to exit the tobacco business.

Competitor Walgreen (WBA -0.93%) recently reported a 3.7% increase in revenue during January on the back of a 2.4% increase in front-end sales. Walgreen has been consistently reporting better front-end sales than CVS over the last several months, so the company seems to be gaining participation in that area. 

Rite Aid (RAD -20.53%) is in a different situation. Though the company is reorganizing its operations, it has not been able to generate consistent sales growth over the last few quarters. Sales for the 47-week period ended Jan. 25, 2014, increased 0.6%, while front-end same-store sales were flat compared to the prior year.

Management estimates CVS will lose $2 billion in revenue -- about $1.5 billion directly from tobacco sales and another $0.5 billion from the rest of those shoppers' baskets -- due to the decision to stop selling tobacco products. This means that CVS could continue losing market share in front-end sales, especially versus Walgreen, which has been performing strongly in that segment lately.

But the company seems quite confident of the fact that expanding its position in health care will more than compensate the negative impact from exiting tobacco in the coming quarters.

In the words of CEO Larry Merlo:

There is a far greater focus emerging on health outcomes, managing chronic disease and reducing costs. And exiting the tobacco category more closely aligns us with the goals of patients, clients and providers positioning our company for future growth. It is also important to recognize that we are doing this from a position of strength. 

MinuteClinic is a compelling growth driver for CVS: The company opened 74 new clinics during the quarter, bringing the total to 800 clinics and growing. The segment delivered a 10% increase in revenue during the quarter despite tough comparisons due to a strong flu season in 2012, and management plans to open at least 150 new clinics in the coming year.  

The company has also signed a 10-year agreement with Cardinal Health, forming the largest generic-drug-sourcing operation in the U.S. The 50-50 joint venture is expected to be operational in July of this year, and it will provide the opportunity to generate higher volume and increased purchasing power in order to reduce costs and efficiently benefit from the generics boom for years to come.

Bottom line
CVS is transforming itself from a simple drugstore to an integrated health care provider, and the recent earnings report shows that the strategy is generating sound financial results. On a long-term basis, betting on health care versus tobacco is a no-brainer considering demand trends and market opportunity, so investors in CVS have nothing to worry about, as the company is strongly positioned for sustained growth.