New York City Bans Tobacco Sales In Pharmacies; Will Walgreens Follow CVS's Lead And Exit This Category?

It’s been a rough summer for the tobacco industry.

After the U.S. Food and Drug Administration announced plans to limit nicotine intake, the New York City Council voted Thursday to raise the price of cigarettes, halve the number of licensed retailers and, in a move causing more widespread disruption, ban cigarette sales in pharmacies.

For CVS Health Corp (NYSE: CVS), this news doesn’t mean much. CVS stopped selling tobacco by October 2014 and already suffered the brunt of related financial fallout.

Walgreens Boots Alliance Inc (NASDAQ: WBA) has also taken steps to deemphasize the category, but Baird Equity Research noted it hasn’t realized the worst of possible sales declines. The tale of CVS may give some indication of the effects of a more pointed pullout.

The Lesson Of CVS

In the year after its exit from the tobacco market, CVS suffered a $2 billion revenue loss from forfeited sales of cigarettes and related products. By Baird estimates, the lost sales ultimately spilled $315 million in earnings before interest and tax. Individual stores were seen to have lost about $260,000 in annual revenue and $40,000 in EBIT.

“Since tobacco likely took up so little space, we believe it’s challenging to cut costs enough to blunt the impact of the immediate product revenue declines,” senior analyst Eric Coldwell wrote in a Friday note.

Industry Extrapolation

If Walgreens is any similar, its 8,100 retail stores contribute unbuffered tobacco-related revenue of about $2.1 billion annually.

Current legislative risks are concentrated in NYC, but in light of the mandated regional exit, Walgreens may opt to accelerate its strategy to reduce cigarette exposure across the board.

“We’ll continue to obviously minimize and reduce visibility to tobacco in our drugstores,” Chief Operations Officer Alex Gourlay said in the firm’s end-of-2016 report. “But you should expect that we’ll continue to see reducing sales in tobacco category in Walgreens going forward.”

Coldwell considered the CVS approach the makings of a “conservative upper risk bound” for Walgreens. Nonetheless, he maintains an Outperform rating on the stock with a $90 price target, justified in part by the company’s U.S. restructuring and renegotiated deal with Rite Aid Corporation (NYSE: RAD).

At the time of publication, Walgreens was trading at $80.93, up 1.5 percent on the day.

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