CVS On Fire After Snuffing Cigarettes

Last year, CVS Health took a bold stand for its customers' health by banning tobacco sales. That's turning out to be healthy for the bottom line as well.

In CVS's first full quarter after it stopped selling tobacco, net revenues increased 12.9 percent to a record $37.1 billion. Revenue continued to rise in the most recent quarter (ending June 30), going up to $37.2 billion, a rise of 7.2 percent over the same period last year. Operating profit was also up, 2.5 percent over last year.

That's not to say that halting tobacco sales was entirely without consequence. According to most estimates, tobacco had accounted for about $2 billion in sales annually. CVS reported that in the fourth quarter of last year, front-end sales dropped 8 percent, largely due to the tobacco ban; with tobacco in place, front-end sales would have risen 2 percent.

So how does CVS come out on top in this situation?

Basically, because compared to its major competitors, it gets more money, proportionately, from its drug operations than its front end. In the most recent quarter, CVS reported 71.6 percent of its total sales revenue came from pharmacy operations; for Walgreens Boots Alliance, its biggest competitor, that figure was 64 percent. While Walgreens has more overall revenue, CVS is now the No. 1 seller of prescription drugs in the U.S.

CVS is in that position, not just because of the tobacco ban, but because of aggressive moves it has made to expand its pharmacy operations in several directions. It now has more than 40 agreements with regional health care providers, mostly hospital systems, to provide low-cost pharmacy services to their patients; this is roughly twice as many as Walgreens. More recent deals include the $12.7 billion purchase of Omnicare, the nation's largest provider of pharmaceutical services in nursing homes, in May, and the $1.9 billion deal announced in June to buy the pharmacy operations and clinics of Target Corp., rebranding all of Target's approximately 1,600 in-store pharmacies as CVS outlets. This deal will bring CVS' total outlets to about 9,600.

Adam Fein, a drug industry consultant, says the Target deal makes sense for CVS in terms of geography as well as overall growth. "There is relatively limited store overlap, so the Target-based pharmacies should not significantly cannibalize any nearby CVS retail pharmacies," Fein says. Seattle, Denver, Portland and Salt Lake City are major urban centers where CVS's presence will be significantly improved by the Target acquisition.

CVS's emphasis on prescriptions, and wellness more generally, makes the decision to stop selling tobacco almost self-reinforcing. Health care systems, and their insurers, feel more comfortable referring their patients/clients to stores that don't sell tobacco. Since the ban, "We've been able to accelerate partnerships with leading health systems across the country," CEO Larry Merlo told the New York Times. (One of these is Caremark, the prescription-benefits unit owned by CVS itself; last fall, it announced that patients who fill their prescriptions at a pharmacy that does not sell tobacco products get a $15 price break.)

Of course, CVS is not neglecting the front of the store. In June, the company announced an initiative to revamp its retail offerings, with a particular emphasis on healthier items. Fresh and refrigerated foods will be added to some 500 stores. The emphasis on healthier foods dovetails with CVS's desire to be seen as more of a health destination. Health and beauty aids will also be improved, with more products and better merchandising.