One of the companies that benefitted hugely from the Covid-19 pandemic was diagnostic testing company Quest Diagnostics Inc (DGX, Financial), which operates a national network of full-service clinical labs and over 2,200 patient service centers. That major tailwind has since subsided, and while there are still growth opportunities for clinical testing companies, the reduction in Covid-related income has made a wreck of the stock.
Quest develops and delivers diagnostic tests and services such as routine testing, non-routine advanced clinical testing and anatomic pathology testing. Key operating brands include Quest, AmeriPath, Dermpath Diagnostics, ExamOne and Quanum. Customers include patients, clinicians, hospitals, independent delivery networks and many more. The company also provides risk assessment services for the life insurance industry.
How big was the Covid-19 pandemic boost?
Quest was at the forefront in the battle against the Covid-19 pandemic and played on important role in terms of broadening access to lab testing. The company provides both molecular diagnostic and antibody serology tests to aid in the diagnosis of Covid-19 and the detection of immune response to the virus. Over 72 million of these tests have been performed. The company built up its logistics network to handle this extraordinary workload and worked with governmental agencies, hospitals, retailers and other organizations. The company also provides data on Covid-19 to federal, state and local public health authorities, including the Centers for Disease Control and Prevention (CDC).
Peak Covid is in the past for the U.S. as hospitalizations and deaths in the country have plummeted, and Quest's revenues have declined as well. Revenues are expected to decline approximately 10% this year from the peak reached in 2021 and decline again in 2023. After 2023, the company says it should resume its normal growth rates.
Financial review
Quest recently reported third-quarter operating results that showed a revenue decline of 10.4% year over year. However, the company does separate its Covid-19 related testing business with its base business, and the base business increased 5.1% compared to the prior-year period. Adjusted operating income declined 39.1% to $423 million due to lower high margin Covid-19 tests, inflationary pressures and investments in growth.
Quest typically generates strong levels of free cash flow as it not a capital-intensive business. Free cash flow for the first nine months of 2022 totaled $1.1 billon and the company is calling for $1.3 billion in free cash flow for the full year. Share repurchased year to date totaled $947 million and the divided payouts totaled $230 million.
One the balance sheet, the company carries $700 million in cash and equivalents almost $4.0 billion in debt. However, with expected Ebitda this year of approximately $2.0 billion, the company’s leverage ratio is not excessive.
Valuation
Quest provided guidance for 2022 which calls for a total revenue to decline between 9.9% and 8.6%, though it also expects base revenues to increase approximately 5.0%. Earnings per share is expected to be in the range of $9.75 to $9.95. Consensus analyst EPS estimates are in the middle of that range at $9.81, which puts Quest stock selling at a forward price-earnings ratio of 15. However, EPS for 2023 is expected to decline further due to the ongoing reduction in Covid-19 testing revenues, and most analysts are shooting for $8.50 for 2023 EPS. Forward enterprise-value-to-Ebitda ratios average above 11.
The GuruFocus discounted cash flow calculator estimates a fair value for the stock that is close to the current stock price when using next year's EPS estimate of $8.50 as the starting point and an 8.0% long-term growth rate, with an 11% discount rate.
The company currently pays an annualized dividend of $2.64, which produces a dividend yield of 1.83% currently. That is slightly above the S&P 500 dividend yield of 1.68%.
Guru trades
Gurus who have purchased Quest stock recently include Steven Cohen (Trades, Portfolio) and Ray Dalio (Trades, Portfolio). Gurus who have reduced or sold out of their positions include Jeff Auxier (Trades, Portfolio) and Jim Simons (Trades, Portfolio).
Conclusion
The Covid-19 testing drop off will stabilize at some point next year and will still provide a steady stream of high margin revenues going forward. Other possible upsides for Quest include higher levels of lab consolidation, which will be driven by Medicare reimbursement cuts. The company also has plans to monetize its treasure trove of lab data that is has collected. Direct-to-consumer lab testing kits is another potential driver and the company hopes to generate $250 million revenues by 2025 through that channel.
The company appears to be fairly valued at this time based on its GF Value, but it will likely be difficult to invest in this range as revenues and earnings are expected to decline for one more year before turning around. Investors may want to wait for the stock price to retreat to lower valuation levels in my opinion as the stock should adjust to the delay in the return of normalized growth.
