CalPERS Applauds CVS Caremark's Tobacco Exit

NEW YORK (TheStreet) - The California Public Employees Retirement System (CalPERS) said on Wednesday evening it applauded drugstore chain CVS Caremark's (CVS) decision to end its sale of tobacco products in the company's 7,600 pharmacies nationwide by Oct. 1, 2014. The $277.2 billion pension is the nation's largest and has already taken a stand against big tobacco, divesting its passive investment in tobacco stocks in 2000.

"We applaud the decision by CVS to take this bold step and end its sale of tobacco products," CalPERS said in a statement. "The health of our members and their families is a top priority for our organization and clearly the use of tobacco is a key driver in the costs of health care. CVS' leadership helps promote a culture of wellness and health in our communities across the nation."

CalPERS is an important investor in CVS Caremark, and the first major fund to publicly support the company's landmark decision. The fund held about 3.38 million CVS Caremark shares as of the third-quarter of 2013, worth about $221 million according to Wednesday closing share prices.

CVS Caremark shares fell just over 1% on Wednesday after announcing its decision to stop selling tobacco products by the start of the third quarter of 2014.

The move by CVS Caremark raises interesting questions about corporate governance and socially responsible investments that may gain further notice if other large CVS investors also take a stand.

Short-Term vs. Long-Term

CVS's decision could have a negative short-term impact on the company's earnings. However, the decision to end tobacco sales could also have a positive long-term impact on the company's positioning in the pharmacy business, especially as it works to expand its healthcare services in coming years.

TheStreet's Nicole Urken said in a Wednesday evening analysis that CVS's closer ties to healthy living categories could benefit long-term shareholders. Strong performing supermarkets and restaurants such as Whole Foods Market (WFM), Starbucks (SBUX) and Chipotle Mexican Grill (CMG) have all differentiated themselves with a focus on consumer health that's also translated into rising profitability.

It's also important to remember what CVS does.

CVS is one of the biggest pharmacy networks in the world and it's stores sell also drinks, snacks and other non-perishable foods that one might buy in a supermarket.

Nevertheless, the company's biggest recent investments are in healthcare. CVS acquired pharmacy-benefit-manager (PBM) Caremark in 2007, building a hybrid retail-PBM business model. Now, the company is investing heavily in a nationwide network of so-called MinuteClinics that may be a low-cost alternative to some doctor visits.

In that sense, CVS, above other competitors, appears to be the pharmacy chain with the biggest investment in healthcare. Thus, it also may have the greatest economic reason to end its sale of tobacco. Consumer perceptions are likely to be a big aspect of whether or not CVS can succeed in its healthcare investment.

CVS said its move would impact 2014 earnings guidance by 6-to-9 cents per share, but that the company "has identified incremental opportunities that are expected to offset the profitability impact." The company made no changes to its five-year financial projections.

From a short-term perspective, CVS's decision could lower the company's earnings by a few pennies. CVS said on Wednesday that ending tobacco sales may cause the company to lose $2 billion in annual revenue, or approximately 17 cents a share.

"Ending the sale of cigarettes and tobacco products at CVS/pharmacy is the right thing for us to do for our customers and our company to help people on their path to better health," Larry J. Merlo, CEO of CVS Caremark said in a statement. "Put simply, the sale of tobacco products is inconsistent with our purpose," he added.

CalPERS' support of CVS decision did not cite any economic reasons and characterized its statement in the vein of what is important to the fund's constituents.

The fund, however, has a long tradition on putting its money behind social issues that also have an economic element. When divesting tobacco stocks in 2000, CalPERS cited the risk of prolonged litigation to its investment. The fund held over $500 million worth of tobacco stocks at the time.

In 2011, CalPERS said it would divest its holding of companies doing business in Iran and Sudan, causing the fund to sell shares in eight firms worth a total of $160 million. The fund and the California State Teachers Retirement System (CalSTRS) have also recently been pressed by students and California state employees to divest their holding of fossil fuel companies.

CalSTRS, another CVS shareholder, declined on Wednesday to discuss the company's decision to end tobacco sales. However, the fund eliminated new investments in tobacco in 2000 and divested its portfolio of all tobacco in 2009 on the basis of its negative impact on human health and how the nature of that impact affects the industry's long-term profitability.

That investment decision was characterized as part of the fund's fiduciary duty to its members.

Fiduciary Duty and Public Policy

In coming weeks and months, will be interesting to see whether CVS's cessation of tobacco sales will be seen as a compelling fiduciary decision or not. It may also prove yet another example of the tension between short-term and long-term shareholder interests.

If investors were unimpressed by the move, analysts covering CVS's stock appear to believe it could benefit the company in coming years.

"While we expect this change might be a near-term headwind, we believe it will help CVS differentiate itself from other large retail pharmacies and it may be an incremental benefit to the PBM's selling season," Leerink Swann analyst David Larsen  said in a Wednesday client note.

Bank of America Merrill Lynch called the tobacco decision a "smart strategy" and noted that tobacco sales were not important to the company's profitability. "We believe the clipped contribution pales in comparison to likely political and social gains to be had with a widespread media focus [on Wednesday]."

"Stopping the sale of cigarettes and tobacco will make a significant difference in reducing the chronic illnesses associated with tobacco use," Troyen A. Brennan, CVS Caremark Chief Medical Officer, said on Wednesday

The company also said its decision to stop selling tobacco products reflected positions taken by the American Medical Association, American Heart Association, American Cancer Society, American Lung Association and American Pharmacists Association.

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