Is a Tobacco Ban Bad for CVS?

Drugstore chain CVS Caremark (NYSE: CVS) announced earlier this week that it would cease sales of tobacco products in all of its 7,600 retail stores. It’s a bold move. But is the CVS tobacco ban bad for business?
In the press release announcing the decision, CVS said it hoped it was setting an example and that other drugstores would follow.
Why would CVS decide such a thing?
“The CVS announcement sends a powerful message that if you’re in the business of health care you shouldn’t be in the business of selling tobacco products,” says a spokesperson for the Campaign for Tobacco-Free Kids.
This seems like a simple and reasonable rationale for the tobacco ban. The numbers behind the decision aren’t quite so simple.

CVS Tobacco Ban: Good or Bad for Business?

The CVS tobacco ban will result in the loss of $2 billion in revenue, according to CVS estimates. Approximately $1.5 billion would be from tobacco products themselves, while an additional $500 million would be from other items that customers buy alongside their tobacco purchases.
CVS is expected to report $126 billion in revenue for 2013, so arguably $2 billion in lost revenue isn’t the end of the world for CVS.
But it’s not as simple as lost revenue.
Cigarettes and other tobacco products are notoriously low-margin products.
By clearing out the low-margin tobacco products, CVS is also making room for new or expanded product offerings. For example, tobacco products – with an average margin of 15% – could easily be replaced by health and beauty products, which carry margins of 30-50%.
It remains to be seen whether competitors like Walgreens (NYSE: WAG), which operates over 8,600 stores, will follow the CVS tobacco ban and decide to ban tobacco sales in its own stores.
Target (NYSE: TGT) actually ceased its sales of tobacco in 1996 after determining that it was too expensive to manage the process of selling tobacco in its stores.
Interestingly, both Family Dollar (NYSE: FDO) and Dollar General (NYSE: DG) recently started selling tobacco products. Dollar General said in December that sales of tobacco products seemed to be driving increased traffic to its stores.
While casually referred to as “CVS,” the official name for the company is “CVS Caremark Corporation.”
Though it isn’t the most publicly visible part of the corporation, Caremark is responsible for almost two-thirds of the company’s revenue. Caremark is a pharmacy benefit manager handling prescription drug coverage for large employers and institutions.
With that in mind, Caremark is in the business of keeping people healthy. And with its identity as a drugstore, so is CVS. This is truer today than in previous years now that CVS has quietly added in-store clinics to many of its locations.
Indeed, CVS Caremark is in the business of promoting health and preventing disease. And selling tobacco products seems to be in direct conflict with that message.

The Bottom Line

After the CVS tobacco ban announcement, shares of CVS fell by 1% while the broader market remained flat. Still, there hasn’t been much of a reaction from investors.
While the company expects to pass up $2 billion in revenue as a result of the tobacco ban, it also said that it expects to “offset the profitability impact” of the ban. In plain English, that means CVS thinks it has identified ways to replace the lost revenue of tobacco sales with new sources of revenue.
Of course, it remains to be seen whether the CVS tobacco ban will have an impact on its profitability. Regardless, this appears to be the right moral and business decision for CVS.

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