CVS Caremark (CVS) announced last week that it will stop selling tobacco products in its drugstores. Ending sales of this ironic product will likely trim $2 billion from CVS’ top line revenue, but the free PR and plans to replace the revenue with other products may help ease the financial pain and steady CVS stock. We feel that ending sales of tobacco products is a no-brainer for CVS. Its counter to the company’s stated mission and tobacco sales in the U.S. are in a long-term decline.
Critics of this move still have valid concerns from a financial perspective. Drug stores have a very small percentage of national tobacco sales, but those customers are still important for overall performance. If a customer buys tobacco at CVS, they are also likely buying other products at the same time and those additional sales may not come back. However, we like the move because it puts CVS on the moral high ground compared to Rite Aid (RAD) or Walgreen’s (WAG).
Is this move worth $2 billion in PR and publicity? We think it is and it looks like most CVS stock investors agree.
In the next chart, you can see that CVS stock dropped on Feb. 5 (the date of the tobacco announcement) only to stop at support and rally through the earnings report on Tuesday, Feb. 11. The technical pattern formed last week is similar to a morning star, which is quite bullish. It looks like investors are willing to buy the dips and give this radical strategy the benefit of the doubt.
We have been following the pharmacy group for a while as it prepared to take advantage of the windfall from the Affordable Care Act (AKA Obamacare). Regardless of your political leanings, it should seem reasonable to expect that consumption of healthcare products will rise as healthcare insurance becomes more widely used and available. We have already written about this several times but we still feel strongly that the full impact of the ACA in the healthcare sector has yet to materialize.
CVS is up over 39% since the beginning of 2013 and, based on the company’s earnings report on Tuesday, we expect that trend to continue in 2014. The company reported both top and bottom line numbers above analysts’ expectations, increased guidance for the first quarter, and re-affirmed full-year guidance for 2014. As a result CVS stock popped up more than 3%.
What we like about CVS is not only its position to take advantage of an expected ‘lift’ in healthcare consumption but how it is positioning itself as a healthcare provider. CVS operates small clinics, usually staffed by nurse practitioners who can assist patients with routine medical visits on site. It currently operates nearly 800 clinics and expect to double that over the next few years.
If CVS can control more of the value-chain, profitability, customer loyalty and operating margins should continue to improve. It’s not a secret that medical care in the U.S. is incredibly inefficient from an operational standpoint. However, that should change (for the patients’ benefit) if companies like CVS (who are operationally skilled) are able to expand into that part of the market successfully.
From a technical perspective, CVS stock is in an uptrend but has been pulling back in a narrow channel since the beginning of the year. This pattern is called a bull-flag and a breakout above the channel is a buying opportunity. Our short term target is the top of the flag at $72 per share. However, if this breakout follows the same pattern it did in 2013 and 2012, the longer term target is a measured move to $80 based on the run up to the consolidation in January.
As an alternative to an outright long position, call options on CVS are particularly attractive right now. Longer dated options have deflated in value as the earnings report was released and may offer a more attractive risk/reward profile for investors willing to make a leveraged trade.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.