Drugstore giant CVS Caremark (CVS 2.00%) made waves in early February after disclosing its intention to forgo tobacco sales starting in October. While some pundits questioned CVS' motives, the policy makes sense for a company that generates the vast majority of sales from health-care products and services. It would likely also help the company stand out in the battle for drug-prescription market share, a fight that pits CVS against mega chains like Walgreen (WBA 1.04%) and Rite Aid (RAD -33.90%). So, is a tobacco-less CVS a good bet at current prices?
What's the value?
CVS started out as a chain of discount convenience stores, selling a range of impulse items for on-the-go consumers; items such as carbonated beverages, cigarettes, and personal-care items. While the company had been morphing into a health-care player through the addition of pharmacies to its stores, it made a bold statement about its future direction with the blockbuster purchase of pharmacy-benefits manager Caremark in 2007. The deal significantly increased the company's size and added a benefits-administration franchise that created cross-selling opportunities for its retail operation, much to the chagrin of its competitors.
In FY 2013, CVS continued building on the multi-year growth trajectory for its top line, reporting a 3.2% gain. In its retail segment, growth was achieved thanks to a bump up in the number of prescriptions filled as well as from a continued expansion of its store network; CVS ended the period with more than 7,700 locations. On the downside, though, front-end store sales logged a comparable-store sales decline due to a continued fall in customer-traffic volumes.
Looking into the crystal ball
CVS' management seems to have wisely realized that the company's future doesn't lie in the retail sales of impulse items, an area where the company is anecdotally at a competitive price disadvantage to the mass merchandisers. Instead its future lies in the sale of health-care-related products, primarily pharmaceuticals.
Long before CVS' new tobacco policy was making headlines, management had been making moves to strength its health-care focus. This involved positioning its pharmacists as trusted health-care advisors, able to counsel consumers on subjects within their sphere of competence, like medication management. CVS has also been adding health-care clinics to a subset of its store base, so-called MinuteClinics, which are staffed with licensed professionals and are capable of performing minor medical treatments.
Not surprisingly, CVS isn't alone in its shift toward a health-care focus, as its major competitors have embarked on similar initiatives. Like CVS, drugstore kingpin Walgreen has been adding health-care clinics to its stores. It has also been opening offsite clinics at worksites of major employers within its geographies, an innovative marketing scheme that puts the company's brand in front of large swaths of employees.
Walgreen has also been investing heavily in the specialty-pharmacy space. This is highlighted by its acquisition of BioScrip's specialty pharmacy unit in 2012, a niche area that focuses on the most chronically ill members of the population.
Likewise, Rite Aid has been reshaping its chain of drugstores. It is pursuing a nationwide remodeling program that provides for a more open layout and in-store ambassadors who can help consumers navigate their medication-management issues and general health-care concerns.
Even more so than its competitors, the company has been aggressively pursuing the 65 years of age and older population. It created a loyalty program specifically for that age cohort, the largest purchasers of prescription drugs on a per-capita basis.
Rite Aid has also been increasing its participation in the wellness-product segment through a long-term partnership with retail-nutrition giant GNC. It's a successful pairing that has added more than 2,000 in-store wellness boutiques to Rite Aid's store base and has allowed it to leverage GNC's popular brand name and product lines.
The bottom line
While perhaps somewhat controversial, CVS' abandonment of tobacco sales makes sense; especially given the company's prominent position in the health-care industry and mission of enabling positive health-care outcomes for its customer base. The three major drugstore chains having already built national store footprints. Therefore, future growth for CVS' retail operation will hinge on an ability to take market share from competitors by differentiating its brand, something it has likely achieved with its policy stance. Even after a strong run over the past 12 months, CVS looks like a long-term winner.