On Dec.31, Chris Davis (Trades, Portfolio), the portfolio manager of Davis Financial Fund, reported to adding Laboratory Corp. of America Holdings (LH). So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity.
Laboratory Corp. is an independent clinical laboratory company. As of Dec. 31, 2012, the company had a national network of 50 primary laboratories and about 1,800 patient service centers, along with a network of branches and STAT laboratories (laboratories that perform certain routine tests quickly).
A key driver for growth in the industry and also for the firm has been expanding through acquisitions. Acquiring other laboratories and trying to reduce the high fixed-cost component of operating them is crucial to remain profitable in the long term. For this reason, LabCorp acquired MuirLabs, focusing on adjacent fields such as central lab testing for clinical trials. Moreover, the acquisition of Medtox Scientific will strengthen the expertise in specialized toxicology testing. Other acquisitions include Orchid Cellmark, Westcliff Medical Laboratories and Genzyme Genetics. We think there is much space for these operations because there are plenty of clinical labs remaining to be acquired.
The firm plans to expand its esoteric testing capabilities because they are more profitable than routine tests. As a matter of fact, it will be crucial to enter into various agreements with diagnostic companies that develop esoteric diagnostic tests. This will be extremely important for obtaining higher revenues from specialized testing.
In terms of valuation, the stock sells at a trailing P/E of 14.8x, trading at a discount compared to an average of 27.3x for the industry. To use another metric, its price-to-book ratio of 3.1 indicates a discount versus the industry average of 3.61 and the price-to-sales ratio of 1.47 is below the industry average of 3.46. All these metrics indicate that the stock is undervalued relative to its peers.
Earnings per share (EPS) increased by 6.5% in the most recent quarter compared to the same quarter a year ago. Also, it has demonstrated an upward trend over the past 10 years which is a good signal. We include in the next graph the stock price because EPS often lead the stock price movement.
Looking at the financials, the company has a strong balance sheet as well as good cash that allow the company to buy back shares. During third quarter 2013, it repurchased 2.9 million shares for $288 million and $304.1 million are pending until authorization. Also, an additional $1 billion share repurchase program was authorized.
Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has slightly increased when compared to its ROE from the same quarter one year prior. This is a signal of strength and could be attractive for investors. Furthermore, it is higher than competitors such as Quest Diagnostics Inc. (DGX), Omnicare Inc. (OCR) and Express Scripts Holding Co. (ESRX).
For a long-term perspective, I would advise fundamental investors to consider adding Laboratory Corp. to their portfolios as its acquisitions and development of new areas have the potential to expand LabCorp´s customer base.
Hedge fund managers have also been active in the company. Gurus like Steven Cohen (Trades, Portfolio), Jim Simons (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Wallace Weitz (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Charles Brandes (Trades, Portfolio), Richard Pzena (Trades, Portfolio) and Scott Black (Trades, Portfolio) have invested in it.
Disclosure: Vanina Egea holds no position in any stocks mentioned.
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