For those of you who missed it last month, CVS Caremark, a publicly traded pharmacy / distributor / convenience store empire, generates about $123 billion in sales every year. Of that, roughly $2 billion is from tobacco; mostly cigarettes. It’s a highly profitable item that brings in repeat business (folks stop in for a pack and are likely to pick up a bottle of Coca-Cola, maybe a stick of gum, too). Very few things in life drive that kind of repeat business.
Management decided it wanted to send a message telling the world what CVS means, values, and believes. (It’s straight-up signaling theory.) They think selling a product that kills is inconsistent with healing people. Can’t fault them on the logic.
With overall sales of $123 billion, the move represents about 1.6% of revenue. But that’s deceiving. Cigarettes are the second most profitable item sold in a convenience store environment, coming only after non-alcoholic beverages like Coca-Cola or Gold Peak Tea. They have no fixed cost against them (the building still costs the same, the light bill costs the same, the employee salaries cost the same), meaning that to identify the profitability loss, you’d have to look at a roughly estimated gross margin, not net margins. There are a few variables you have to try and sketch out but the bottom line is this move could cost the company between $300 and $400 million in pre-tax gross profits every year. Before taxes, the move could lower operating earnings between 4% and 6% from what they would have been, but it is likely this will be hidden by new store openings, acquisitions, and price increases on other goods.
For a long-term owner, this may seem like a small, insignificant amount of money, but it’s not. To put it into perspective, the management just destroyed a business roughly the same size as the entire Tupperware Brands corporation. Ultimately, it won’t make a difference from a societal standpoint because the sales will shift to other outlets like specialty tobacco shops or Wal-Mart.
Was this the right move? I can’t decide because I understand why they are doing it, but I think the idea that CVS thinks of itself as a health care company first is mostly the result of the Caremark division because the flagship retail empire is closer to a gas station or the Dollar Store than it is Johnson & Johnson. When you’re selling knock-off chocolates and cheap stuffed bears from China, two-bit cologne and “As Seen on TV” tchotchkes, taking the high moral ground seems both admirable and foolish give that it won’t have an impact.
Should the owners be fine with losing billions of dollars in future wealth because management has moral qualms about a product society continually chooses to make legal and available, especially when it won’t cut net smoking but instead cause those profits to flow to competitors?
I’m not sure how I feel about it because they’re making it out to be some heroic stand, yet it changes nothing. It inconveniences customers. It costs the owners a tremendous amount of future wealth. One potential solution would be a total switch to e-cigarettes, which management says it is considering, given that there are no risks like second hand smoke and they are generally much healthier on the lungs since you aren’t pumping black tar into them.
Not that it matters, but I have no stake in CVS either way, or any drugstore for that matter. I did have my parents purchase some shares of Walgreen earlier in the year when it was trading at very close to its intrinsic value and offered a better relative opportunity cost than most other stocks at the time, which they continue to hold (though I wouldn’t recommend they add to the position since the shares surged by 20%+ in the past few weeks resulting in a situation where there are better deals out there).