Where there's smoke, there's fire. But what about where there's no smoke?
The company formerly known as CVS Caremark announced two big changes this week. First, its name changed to CVS Health Corporation (CVS -1.62%). Second, the giant pharmacy benefits manager and retailer removed all tobacco products from its stores effective Sept. 3 -- almost one month earlier than originally scheduled. With no more smoke, could CVS Health's shares actually catch fire?
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Cold turkey
On the surface, discontinuation of selling tobacco-related products seems like a bad business move. When CVS first announced the decision in February, the company acknowledged that it stands to lose around $2 billion in annual revenue by removing cigarettes and tobacco from its stores.
That anticipated loss doesn't stem solely from tobacco-related purchases. Shoppers who used to go to CVS stores to buy cigarettes tobacco also sometimes bought other products. With CVS no longer stocking the tobacco products, those customers could take their business elsewhere.
No one can argue that $2 billion is a trivial sum, either. Earlier this year, CVS stated that booting tobacco products would shave $0.06 to $0.09 per share from its 2014 earnings. With the expedited implementation of the no-tobacco policy, it stands to reason that the negative impact could be on the higher end of that range.
A healthy decision
Despite the potential financial concerns, the market has shrugged off CVS' tobacco decision. Since the initial announcement in February, shares are up 22%. CVS Health's stock moved up nearly 1% after the company stated that tobacco products would be removed from stores earlier than previously scheduled.
Source: CVS Health
This positive movement likely stems from a couple of factors. First, CVS hinted in February that it "has identified incremental opportunities that are expected to offset the profitability impact". One of those "incremental opportunities" could be related to the company's major initiative to promote smoking cessation. Of course, products to help cigarette smokers kick the habit are available at CVS stores nationwide.
The second potential reason for overall market optimism could be that the long-term impact of CVS' repositioning might be more beneficial than some think. Employers, insurers, and accountable care organizations, or ACOs, are all looking for ways to promote good health as a way to control healthcare spending.
These same entities also partner with pharmacy benefits management companies to control prescription drug spending. CVS Health's PBM business segment generates more revenue than the retail pharmacy business segment. Expect the company to make a concerted effort to leverage its corporate commitment to healthy living into new business opportunities.
Fiery call
Is the time right to buy CVS Health stock? I think it could be -- despite the sizzling run so far this year and despite the financial impact of the company's tobacco decision.
My view is based on macro trends and valuation. Health reform and an aging U.S. population both provide wind for the sails of PBMs and pharmacy retailers. CVS Health ranks as the second-largest player in both categories and stands to benefit from these macro factors. I suspect that CVS' projected image as a "pharmacy innovation company" will help.
As for valuation, it's true that CVS Health's stock is at the most expensive point in the past five years. However, its trailing price-to-earnings multiple still hasn't climbed back to pre-recession levels. The stock has plenty of room to run before it hits peak valuation marks. CVS Health might not deliver the awe-inspiring returns experienced over the past two years, but this stock should still be able to warm up investors' portfolios.
