Quest Diagnostics (DGX, Financial) is an American clinical laboratory specializing the provision of diagnostic testing services for cancer, cardiovascular disorders, infectious diseases and neurological disorders.
The company operates in the U.S., U.K., Mexico and Brazil, and maintains collaborative agreements with hospitals and clinics across the globe.
Quest Diagnostics has a market capitalization of $12.8 billion and is currently trading at $94 per share.
Let's take a closer look.
Financials
The company recently reported earnings for the third quarter of 2018. Quest posted a diluted earnings per share of $1.53, up 32.7% from 2017, and adjusted diluted earnings per share excluding amortization of $1.68, up 25.4% from 2017. Reported revenues for the year were projected to be approximately $7.62 billion. Reported diluted earnings per share is now expected to be between $5.57 and $5.64, and adjusted diluted earnings per share excluding amortization expense is now expected to be between $6.53 and $6.60.
The company has a healthy balance sheet, with cash provided by operations on the year of $905 million, compared with $852 million last year. This broadly offsets an annual increase in capital expenditures ($232 million compared with $170 million a year ago). Quest missed revenue expectations by $60 million for the third quarter, leading to a modest sell-off; however, analysts point to a $100 million share repurchase as evidence that the company is operating from a position of strength.
Tough regulatory environment
The clinical testing industry in the U.S. as a whole faces a significant industry disruption in the form of PAMA (Protecting Access to Medicare Act). The legislation is complex, but the key provisions that apply to the sector are those affecting the Medicare Clinical Lab Fee Schedule -- the mechanism by which Medicare payouts for clinical lab tests are calculated. Total cuts to clinical laboratories under PAMA are expected to come in at $670 million for the year, representing an almost 10% decrease. Three-quarters of tests have been affected by the price reductions, with automated testing taking the heaviest hits.
Quest’s lawsuit against the CMS (Centers for Medicare and Medicaid Services) was recently dismissed, leading many in the industry to believe that PAMA will remain a permanent fixture of the market.
This headwind was addressed by Stephen H. Rusckowski, president and CEO, on the earnings call:
“So as we sit here today, PAMA is having the impact on Quest and the rest of the lab market. Increasingly smaller independent labs and hospital outreach labs are struggling financially due to lower Medicare reimbursement, not only directly due to PAMA, but also under contracts with pricing index to Medicare. Some have begun to exit the business citing PAMA as a factor and we're continuing to plan and manage our business as if PAMA is here to stay.
“At the same time, there has been increasing scrutiny of a wide variation in healthcare pricing in the popular press. Consumers and employers who pay for most of healthcare are becoming more price sensitive. Last month, the Wall Street Journal reported that health plans that excluded costly providers can be much less expensive for consumers and employers. Quest offers a great customer experience, and coupled with our scale and efficiency, it makes us an exceptional value in the market compared to hospital outreach laboratories, which often charge two to five times more than Quest.”
Verdict
Management is clearly banking on this tighter environment pruning some of the slower and more cash-strapped competitors. While it remains to be seen whether Quest will be able to weather these forces and emerge as a bigger and stronger company, its diverse range of clinical tests make it one of the forerunners in the race to consolidate the industry in this new market.
This article was co-authored by Stepan Lavrouk, director of research at Atreides Capital LLC and a former research analyst for Almington Capital Merchant Bankers.
Disclosure: No positions.
