Is CVS Health's Anti-Tobacco Strategy Paying Off?

CVS Health's (CVS -0.17%) earnings have finally come around, and the company's decision to cut out all tobacco sales in its stores may not have been such a terrible idea.

Meanwhile, as prescription sales increase, a new wonder drug might help numbers even more once it's approved by the FDA. With a forecasted sticker price close to $15k annually, its profitability is virtually endless -- but once everything shakes out, will payers cough up the cost, or will the numbers drop to something more feasible for the working class person?

A full transcript follows the video.

Kristine Harjes: Is CVS's anti-tobacco strategy paying off? This is Industry Focus.

Hi, everyone. Welcome to Industry Focus, healthcare edition. This is Kristine Harjes and I'll be your host today. Pleased to have Todd Campbell on the line today, one of The Motley Fool's finest healthcare contributors. Todd, how are you doing today?

Todd Campbell: I'm doing a lot better after that compliment.

Harjes: Glad to hear it. We're going to kick off today talking a bit about CVS Health who reported earnings yesterday, Tuesday. If you were to just look at the market reaction to earnings you would think that CVS didn't have the greatest quarter. The stock was down in the neighborhood of 4%. I think it's recovered today maybe a percentage point or so. Actually looking at the earnings, it still didn't seem to me like it was a bad quarter. What happened?

Campbell: I think a lot of investors have been [...] CVS to perfection. I heard you on Market Foolery yesterday talking about CVS. Perfect primer on earnings season for the company. What that got me thinking is, is CVS's strategy the right strategy? Is that why investors are so nervous about what they said during their conference call, that maybe they're concerned that this strategy isn't the best business strategy?

I spent a bit of time looking at some of CVS's top competitors and comparing their quarters to CVS's. Frankly, I think investors might have overreacted a bit and been a bit more negative than they had to be on CVS.

Harjes: You mentioned CVS's strategy. Did you see words in the conference call that would imply that they're not as confident in this strategy anymore? What is this strategy that you're referring to?

Campbell: They made a huge bet last year that makes a lot of sense. They decided they're in the business of improving people's health; why are they selling tobacco products? If they're truly trying to improve people's health they shouldn't be selling these items, and if they're not selling these items then they might be able to use that to their advantage when they're discussing what they bring to the table in the form of pharmacy benefit management services, or in trying to get payers to direct their patients to get their scripts filled within CVS' stores.

In short, the strategy is: stop selling tobacco, leverage that to drive prescription growth and sales growth that way instead.

Harjes: You make a really interesting point there. CVS's business is not necessarily just focused on the front end store sales. In fact, it's back end PBM business is a larger part of the business story as a whole. This tobacco decision is a couple billion dollar loss that they're acknowledging they're willing to sacrifice this and their intention there is clearly that they can leverage this corporate commitment to healthy lifestyle into something worth even more than that.

You mentioned you looked a bit into some comparisons on CVS and some of its competitors. What are we seeing so far? Does it look like that particular strategy is paying off?

Campbell: I'm going to say "yes". In my view, the best comparison is going to be to Walgreens. They're both competing on every neighborhood street corner in America at this point. I compared CVS's retail store business to Walgreens' store business and what I discovered were two things that make me think that CVS is indeed on the right track with its strategy.

First, the amount of prescriptions that CVS filled at its stores last quarter; the growth was greater than it was at Walgreens. CVS filled 4.8% more prescriptions than they did a year ago, where Walgreens filled 4.1% more prescriptions. Growing faster than its peers in that important metric that is a really good indication of what future sales would be as people continue to get those prescriptions refilled over and over again.

The other thing I looked at that gives me confidence is the fact that CVS's market share last quarter actually grew by 60 basis points. It's now 21.6%. Walgreens grew by 20 basis points to 19.3%. You're filling more scripts, and your market share is growing more quickly than your largest peer. In my view, if you're in the business of prescriptions; that's what's important.

I think CVS's strategy is paying off in the retail store business. That brings up another question. Is it paying off in terms of them being able to win additional business on the pharmacy benefit management side; the business they run where they manage drug programs for healthcare payers like insurers and self-insured employers?

When I did theirs I compared it to Express Scripts, another stock that we at The Motley Fool tend to like.

Harjes: They're also the largest PBM.

Campbell: Yeah. What I discovered is that CVS is doing really well versus Express Scripts too. Last quarter CVS's sales in its PBM business were up almost 12%. Express Scripts was only about 1.5%. Another way to evaluate PBMs is to look at the growth in the amount of claims that they're processing. Claims that were processed for CVS were up about 8.7%, while Express Scripts actually dropped a bit.

In my eyes, that's telling me that CVS is outcompeting based on this look at it. Again, its largest competitor in that business. Overall, I think the investors may be overreacting when they sell off CVS on this report. Yes, there's a lot of pain tied to the $2 billion lost sales of tobacco products, but they're making a bigger long-term push. That's to grab as much prescription volume and prescription related revenue as they can. In my view, that's what they're doing.

Harjes: We're long-term investors. That's exactly the kind of thing we like to see.

Campbell: Without a doubt. You don't want to take a short-term approach to a long term trend like aging America and increasingly insured America. Without a doubt; I agree with you.

Harjes: Turning to another trend we keep hearing in the headlines -- and you mentioned Express Scripts and we're talking about PBMs. I want to talk a bit about drug pricing and payer pushback. Particularly with this new class of cholesterol medications called PCSK9 inhibitors. Todd, what's the deal with these drugs? What's the big deal?

Campbell: I'm not going to call them 'miraculous', but what they could do as far as improving the heart disease statistics in America is pretty impressive. For the last 20+ years the go-to treatment for people who were at risk of heart disease have been statins. Statins work very well at reducing the amount of cholesterol that is produced in the liver. You reduce cholesterol, thereby lowering the risk of having a heart attack or stroke.

However, heart disease still remains the leading cause of death among both men and women despite widespread use of statins by tens of millions of patients here in America alone. Research has continued because this is a big indication and people want to try and improve upon it and bring new drugs to market. PCSK9 drugs work differently than statins.

Instead of inhibiting the production of cholesterol in the liver they allow for more receptors to exist within the liver that can clear bad cholesterol from the blood stream. By using PSCK9 inhibitors alongside statins you can actually reduce bad cholesterol levels even further and theoretically -- because it hasn't been proven yet in long-term studies -- it reduced the risk of heart attack and stroke.

Harjes: What's the potential market here? It sounds enormous.

Campbell: It could be absolutely 'break the bank' big. This is something that Express Scripts, CVS, and all healthcare payers are watching very carefully. Regeneron (REGN 0.37%) is the maker of the drug, and along with their partner Sanofi, they wasted no time in setting a price tag of $14,600 per year for this drug when it was approved last month.

Harjes: $14,600 a year?! That's insane.

Campbell: Yeah. Considering the fact that the addressable patient population out of the gate could be as much as 10 million patients, you're talking about breathtaking potential sales for this class of drugs. If 500 thousand people take Praluent then you're still talking about $7.3 billion in sales for that drug in the coming year.

Harjes: Of course, they're probably going to have to split some of that market with Repatha from Amgen (AMGN 1.11%) that should be slated for an FDA decision on August 27^th.

Campbell: Yeah. Payer pushback is huge on drugs overall. We've seen it in the news a lot because of hepatitis C drugs, we've seen it with cancer drugs, and like you said, with competition coming from Amgen's drug, Pfizer's got one they're working on; you could absolutely see price competition bring the net prices that are being paid for these drugs, or the discounts they're being offered get bigger and the net price falling.

Even if you're talking about a 40% to 50% decline in gross to net, you're still talking about a drug that could do $3.6 billion a year treating 500 thousand people. That's only on an addressable patient population of 10 million. They've got ongoing studies that theoretically could one day make this a standard of care for anyone at risk of heart disease; not just those with genetic mutations that make them susceptible or people that have previously had a stroke or heart attack. If that happens, who knows how big this market could be?

Harjes: Do you have any estimates of what a realistic sustainable price could be here?

Campbell: I think it's probably more likely that you'll see pricing come down to about $7000 to $8000. I think that will happen over the course of the next 18 months to 2 years. It really depends on a lot of things, including how aggressive Express Scripts and CVS are in wanting to do exclusivity deals like they did with Gilead and AbbVie and deals with exclusive use for their drugs to try and play to two off each other to get prices down.

I think that's probably fair; $7000 to $8000. Even then, you're talking about billions of dollars in sales per year for each of these companies that roll out these drugs.

Harjes: Either way you slice it you still have some drugs that are slated to be absolutely wildly successful here.

Campbell: I think so. As an investing show we're trying to help our fellow Fools figure out how to approach these companies. I think you have to look at Amgen, you have to look at Regeneron, you have to look at Sanofi; you have to keep these thoughts in mind because these could be 'move the needle' top and bottom line drugs for these companies.

Harjes: Along that same note I'll remind everyone that on Fool.com we've got a ton of great coverage of all of these stocks. Again, people on this program -- Todd and I -- we may have interests in the stocks that we talk about, The Motley Fool may have formal recommendations for or against them. So do your own research. Don't buy or sell based solely on what you hear.

Todd, I'm going to close us off with that. Thank you so much for being here today and for all of this awesome information. Guys listening, I will talk to you soon. Until then, Fool on!