DGX Disappoints in 3Q, Guides Low

Zacks

Leading diagnostic testing company Quest Diagnostics (DGX) reported earnings per share (EPS) of $1.01 in the third quarter of 2012, down considerably from $1.08 in the year-ago period. However, after taking into account certain charges related to restructuring and integration (17 cents), adjusted EPS from continuing operations came in at $1.18, flat year over year and remained in line with the Zacks Consensus Estimate. The year-ago quarter recorded a cost of 10 cents per share related to restructuring and integration.

Revenues for the quarter were down 2.9% year over year to $1.85 billion nominally missing the Zacks Consensus Estimate of $1.88 billion. Clinical testing revenues during the quarter decreased 2.1% and volume (measured by the number of requisitions) inched down 1.1%. Revenue per requisition was down 1% year over year.

We believe that the overall soft industry trends leading to low volume growth was a dampener for the company. We expect this challenging scenario to adversely affect Quest Diagnostics’ peer Laboratory Corporation of America Holdings (LH) as well, which is scheduled to release its third quarter 2012 results on October 18, 2012.

Among the operating costs, cost of services during the reported quarter stood at $1.09 billion, down 2.4% year over year. Selling, general and administrative (SG&A) expenses dropped 3.1% to $432.6 million. Adjusted operating margin in the quarter contracted 20 basis points (bps) to 17.8% on adjusted operating income of $329.1 million.

Quest Diagnostics exited the quarter with $191.8 million in cash and cash equivalents, up from $164.9 million at the end of fiscal 2011. Cash provided by operating activities for the quarter was $395 million compared with $338 million in year-ago quarter. The company is focused on enhancing shareholders’ value and improving returns on capital. During the reported quarter, Quest repurchased shares worth $50 million and reduced outstanding debt by $292 million.

Lowers Outlook

A disappointing third quarter performance forced Quest Diagnostic to lower its fiscal 2012 guidance. The revenue growth outlook was reduced to 0.5% (earlier outlook being 1%–2%). The company also lowered the higher end of its EPS guidance to the band of $4.45– $4.55 ($4.45– $4.60).

However, the company reaffirmed the operating margin guidance at 18% and $1.2 billion as cash from operations. The company now expects $180 million of capital expenditure compared with previous guidance of $200 million.

Recommendation

We remain cautious about the company as it is continuously witnessing challenges with testing volume. Concerns also linger about the soft industry trends due to a decline in physician office visits, flat pricing, low organic revenue. Moreover, a decline in the company’s fiscal 2012 guidance reflected the fact that the industry trend will not improve in near future, which adds to our concern.

Although, we hold a favorable view regarding the company’s recently announced (on October 11, 2012) massive organizational restructuring in order to increase operational efficiency and restore growth, the near-term visibility remains a matter of concern. We currently have a Neutral recommendation on Quest Diagnostics.

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