Laboratory Corporation of America (Lab Corp) (LH) appears on GuruFocus’ Low Price to Sales screener.
The company is the second largest independent clinical laboratory company in the U.S. LabCorp. maintains a network of 51 primary lab locations and 1,700 patient service centers, and a network of branches and STAT laboratories (labs that can provide instant results for routine tests). The company also maintains a portfolio of specialty testing operations such as oncology, HIV genotyping and phenotyping, diagnostic genetics and clinical trials.
The company’s revenue mix is shown below.
(Source: Lab Corp. investor presentation)
Medicare and Medicaid represent on 20.5% of the revenue so direct exposure to any Medicare or Medicaid cuts arising out of the current budget negotiations should be manageable.
The company faces competition from hospital-based laboratories, physician office labs, and other independent clinical labs (mainly Quest Diagnostics, the largest independent clinical lab company in the U.S. LabCorp controls a little less than 10% of the clinical testing market of $55 billion.
Both Quest and LabCorp derive most of their advantages in the clinical lab market from economies of scale. Routine testing is just that — routine — so there are few opportunities for added value other than accuracy, timeliness and cost.
LabCorp’s management has focused on expanding the company outside the commodity-like routine testing business into other, more lucrative types of testing that offer higher margins. These areas include infectious disease testing, diagnostic genetics, oncology testing, clinical trial testing, identity testing and occupational testing services. Lab Corp brought in revenues of $1.7 billion from genomic and esoteric testing versus revenues of $3 billion for routine testing. Genomic and esoteric volumes and revenue have been growing at high single-digit rates compared to low single-digit rates for the routine testing business.
Clinical laboratory companies also have to negotiate with managed care companies (health insurers) over payments and testing frequency and utilization. In 2006, LabCorp negotiated a 10-year agreement with UnitedHealthcare to become the exclusive clinical laboratory for United’s members. In a novel twist, United pays LabCorp a set amount per United member regardless of the type and number of tests LabCorp performs. This shifts the risk of increased testing from United to LabCorp. Although the current agreement represents only 3.1% of LapCorp’s revenue it isn’t hard to envision a future where more insurers opt to go this route and shift the risks on to clinical lab companies. Managed care companies account for a little under 50% of the volume of tests the company processes so a change in the relationship between managed care companies and clinical testing labs could be significant.
Despite all these challenges, LabCorp has managed to thrive.
EPS and revenue per share have both grown substantially over the previous decade. The growth has been profitable to shareholders, as ROA and ROC have both increased.
Finally, despite the continued cost pressure and the fact that LabCorp does compete partly on cost, management has managed to maintain gross and operating margins at steady, profitable levels.
LabCorp’s strong results are likely due in part to the strong tailwind of a steadily aging population in the United States that is requiring more medical care. The chart below from a Lab Corp investor presentation shows the effect of aging on the number of tests administered.
While skyrocketing healthcare costs in the United States continue to remain on center stage LabCorp doesn’t appear to be part of the problem. The chart below shows that clinical testing accounts for only 2-3% of healthcare costs.
(Source: LabCorp investor presentation)
Hospital care and physician costs remain the biggest drivers of U.S. healthcare spend. With clinical testing crucial to diagnosing and treating patients it is unlikely that cost pressures will be the greatest in this area.
Due to the current recession fears and the ongoing sovereign debt crisis in Europe, the market has sold off precipitously and taken LabCorp with it. As you would expect for stocks appearing on many of GuruFocus’ screeners, LabCorp trades near the lower end of its historical valuation range. However, investors may want to exercise some caution as the upper range of the valuation reflects LH trading at a premium multiple.
Disclosure: No positions