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Now That CVS Makes Sense, It's A Buy

By: Martin Tillier
Posted: 2/11/2014 9:56:00 AM
Referenced Stocks: CVS;CAH

It is funny how, sometimes, things that we take for granted can be surprising, shocking even, to outsiders. I have been lucky enough to live and work in multiple countries, and with each move there have been things that surprise me when I move to a country, often things that the locals don't think twice about. I'm not talking about big, philosophical differences, but small things.

I well remember, for example, the first time I saw people in Tokyo going about their business while wearing surgical masks. I was a little baffled, but once it was explained to me that they were simply people with colds, it kind of made sense; why would considerate people not try to avoid spreading their sickness?

When I moved to the US the biggest initial surprises came from a couple of retail practices. Firstly, gas stations sold beer. To those raised here this may not seem surprising, but to someone from the UK it was quite shocking initially.

Didn't people here understand that mixing driving and drinking was a bad idea? Then there were the drug stores that sold cigarettes. I mean, seriously, somewhere that purported to be concerned with the health of the population selling cancer sticks...?

There are, of course, fundamental differences in the views of the role of government and the ability of people to make correct decisions that lead to these differences, but all the same, when CVS (CVS) announced last week that they were going to remove tobacco products from their stores I had a feeling that my world was just a little more sane than before.

At the time I left the subject alone as, for that reason, it didn't seem all that remarkable to me, especially considering that tobacco accounted for around 5% of CVS’s earnings, so ceasing to offer it wasn't that big of a deal. On reflection, however, the broader shift by CVS to a general healthcare provider rather than just a dispensary that prompted the decision probably is a big deal.

The company just announced earnings of $1.12, a slight beat of analysts' consensus and at the top end of the company's prior guidance. They also increased their predicted range for earnings next quarter, from $0.96-$0.99 to $1.03 to $1.06. The stock has reacted positively in the pre-market and should, all other things being equal, have a good day. It could well be, however, that even after that rise, CVS represents rare value in today's market.


This positive note from the board is welcome and assumes, as I would think, that any loss from the removal of tobacco products will be more than offset by the shift to the profitable business of providing basic healthcare. In fact, I would go further. The move towards being a provider of basic primary healthcare is, in my opinion, a game changer and makes CVS a very appealing long term investment.

One of the things that have come out of the dragged out debate in the US around the healthcare issue is an increased awareness among consumers of the absurdities of cost structure. The long overdue publication of hospitals' pricing last year led to a host of stories such as this, which revealed that hospitals 30 miles apart charged anywhere between $7,044 and $99,660 for the same procedure.

I don't believe people always make rational decisions about healthcare costs, but in an environment of cost awareness, many will take the cheaper option when thinking clearly. A visit to CVS for minor complaints, where the cost is known, makes more sense than a trip to the doctor's office or ER.

CVS is also benefiting from its previously announced partnership with Cardinal Health (CAH) to source generic drugs, a move that will keep costs in the core dispensary business under control to some degree. This is important, as pricing could come under pressure from any cuts in Medicare reimbursement. I believe that the worst of those cuts have already come with those imposed by sequestration, but being prepared for anything when it comes to political decisions is a wise course of action.

It is not often that a large, established company finds a new business opportunity to pursue. It is even rarer for that opportunity to offer a growing market and decent margins from the get-go, but that is what CVS faces with the move toward primary care facilities in its stores. To me, with my alien worldview, a drug store treating bumps, scrapes, sniffles and headaches makes more sense than one that sells products known to damage your health, and, even if just for that reason, CVS looks like a solid buy.