The announcement that CVS Caremark (NYSE:CVS) had decided to stop selling tobacco products in its stores took the market by storm and made headlines around the United States. There is no doubt that this was a huge decision for the company and it will change CVS' future. As of yet, it is unclear how this move will affect CVS in the long-term. Unfortunately, this move and the media hype surrounding the decision have come at a really bad time for cigarette companies such as Altria (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO.DL)
At first glance it appears that CVS's decision will neither affect the company itself or big tobacco significantly. For example, CVS' management has predicted that this move will impact sales negatively to the tune of about $2 billion. On an earnings per share basis, CVS' management feels that EPS will only come in 2% lower than predicted for 2014 -- that's no game-changer. What's more, this move is unlikely to affect Lorillard, Reynolds, and Altria directly as large numbers of smokers are unlikely to stop buying cigarettes overnight just because CVS doesn't sell them anymore.
Indeed, when contacted by Bloomberg, Bill Phelps, speaking for Altria, did not seem fazed by the deal and stated:
We've appreciated working with CVS over the years, and we respect its decision...we will continue to focus on the nearly 250,000 retail stores with whom we work to sell tobacco products to adult consumers in a responsible way.
Having said that, there is actually more to this move than meets the eye and investors should not concentrate on its immediate short-term effects. In particular, this move comes at an interesting time for both the tobacco industry and CVS and one is likely to come off better than the other.
More than meets the eye
Removing tobacco from its stores, as covered above, will cost CVS, as mentioned above, $2 billion a year. Now, as far as I understand it, this figure only includes the direct loss from tobacco sales and excludes any knock-on effects. There is a serious risk that CVS could lose more than just tobacco sales because of this move. However, while CVS may lose sales because of its decision to remove tobacco from its shelves, it will gain customers from the Affordable Care Act.
The 2010 Patient Protection and Affordable Care Act, also known as Obamacare, brings health care to an additional 48 million uninsured individuals. According to some sources, this Act may result in a surge in prescription orders as patients who have minor ailments seek to avoid high emergency room costs and long waits for appointments -- great news for CVS. So, it may have been the perfect time for CVS to make this move after years of consideration.
More bad news for tobacco
Nevertheless, this move by CVS comes at a bad time for big tobacco. You may have noticed that CVS' decision got a lot of press coverage and this is likely to weigh on consumers' minds as big tobacco starts to run enforced advertisements which apologize to the American public for misleading them.
Specifically, the courts have ruled that Altria, Reynolds American, and Lorillard all must publish ads in the Sunday editions of 35 newspapers and on newspaper websites, and also buy prime-time advertising space on CBS, Disney-owned ABC, or Comcast-owned NBC five times per week for a year. In addition, all three companies concerned must publish 'corrective' statements on their websites and affix them to a certain number of cigarette packs, three times per year, for two years.
These advertisements, or corrective statements as they have been called, are damning and they have been described as:
"...shameful and humiliating..."
The statements are designed to make up for years of misleading information from these companies. Under the agreement, every statement should be prefaced by a statement that conveys to readers the fact that:
"...a federal court has concluded that the defendant deliberately deceived the American public..."
This statement must then be followed by one of a list of corrective statements approved by the court, including but not limited to:
"Philip Morris USA, R.J. Reynolds Tobacco, Lorillard, and Altria intentionally designed cigarettes to make them more addictive."
"There is no safe level of exposure to secondhand smoke."
"When you smoke, the nicotine actually changes the brain — that's why quitting is so hard."
These negative statements along with CVS' move lead me to believe that big tobacco may now be heading for a serious sales slump. Effectively, these tobacco companies are paying to tell consumers to stop using their products, while one of the nation's largest drug-store chains stops selling their products -- a double whammy of negative press.
So in conclusion, the move by CVS to stop selling tobacco products within its stores is a drastic decision but it comes at a time when the pharmacy chain is likely to see a surge in prescription orders thanks to the Affordable Care Act. On the other hand, this move comes at a really bad time for big tobacco and only adds to the existing pile of bad press that the industry is struggling to grapple with.