CVS Caremark (NYSE:CVS) warned earlier this year that its decision to ban tobacco sales from all of its stores would come with costs, but investors may not have realized just how widespread they would be.
The retail pharmacy leader declared in February that it would stop selling cigarettes at all of its 7,600 drugstores by Oct. 1. It said it would be hypocritical to advocate for better consumer health when it was also selling products that are a leading cause of sickness and death.
CVS said it sold some $1.5 billion worth of tobacco in 2013, an admittedly small percentage of its $127 billion in total revenue. However, the company said that aside from the revenue lost, eliminating tobacco sales would stub out as much as $0.17 per share annually from earnings, or almost 5% of the 2013 total. For the current fiscal year, however, the impact would only amount to between $0.06 to $0.09 per share, because of the ban's timing.
During the pharmacy chain's second-quarter earnings conference call, it confirmed that it remains on track to see sales fall by $2 billion this year, but what may have caught some unawares was the impact on sales beyond cigarettes. CVS said a broad basket of goods was also going wanting as a result of the ban.
Although front-end same-store sales dropped only 0.4% in the quarter because a number of stores still sell tobacco ahead of the Oct. 1 end date, CFO David Denton said that CVS expects front-store comps to be "negatively impacted" by as much as four or five percentage points in the third quarter and to worsen further in the fourth as the negative effects from kicking the tobacco habit doubles the comps' decline.
Dollar for dollar
So far, rivals such as Walgreen and Rite Aid have failed to follow CVS' lead despite pressure form doctors, politicians, and state attorneys-general. Although the retailers have publicly taken a wait-and-see approach, the precipitous drop in CVS sales may convince them it's better to fight than switch.
Pharmacies are also feeling the competitive effects of deep discount dollar stores and convenience stores that are luring in customers with new and varied products. Dollar General (NYSE:DG) recently said that strong tobacco sales since it introduced the products into its consumables category enabled the segment to far outpace the growth witnessed in nonconsumables last year. Total sales jumped 9.2% in 2013 to $17.5 billion, with same-store sales 3.3% higher as traffic and average transaction amount rose.
Similarly, Family Dollar pointed to tobacco as a primary cause for the robust sales growth it enjoyed last year and for the first six months of 2014. Though third-quarter comps fell 1.8% due to fewer customer transactions, the company's results were likewise best in consumables because of strong growth in tobacco.
Convenience stores have also recently grabbed hold of the latest trend in smoking -- electronic cigarettes -- an area that CVS has voluntarily excluded itself from, saying it prefers to wait until the FDA issues regulations.
This is a fast-growing segment of the tobacco industry, and some analysts believe it can one day overtake traditional tobacco sales, but CVS has turned the market over to the competition.
For all the losses it was willing to accept, CVS hoped that it could win more business from hospitals and insurance companies as a result of its stance. If the company can be seen as helping to make their patients healthier, it just might gain something from the halo effect of its actions. So far, though, that hasn't panned out.
Management said in the latest earnings call that it can't pinpoint any one win for pharmacy benefits management that it could tie to the tobacco ban. Sure, it's still early yet and that win could still come, but this potential tangible benefit to the ban hasn't materialized. Investors need to hope that this branding effort around public health ultimately helps the business overcome these more tangible headwinds.