Medical Diagnostic Labs Facing Medicare Headwinds

GuruFocus.com

Currently medical diagnostic lab stocks are trading at near historical lows for price-to-sales (P/S). At first sight these companies might look like bargains, but lower p/s ratios might be the new normal for these companies. I have taken a closer look at Lab Corp of America (LH), Quest Diagnostics (DGX), and Bio-Reference Labs (BRLI).

The downward moves in these companies have been from decreases in operating profit margins due to lower Medicare and Medicaid reimbursements. Another challenge is the pressure to provide discounted pricing to certain clients that order testing services on a bulk basis, such as certain physicians, hospitals, and other institutions. Currently many of the bills are charged on an individual basis and not subject to bulk discounts. Another issue is that Congress has periodically considered imposing a 20 percent coinsurance on laboratory services. If enacted, the lab companies would be required to attempt to collect that amount from the patients, and in many cases, the costs of collection would exceed the amount actually received.


Below is a comparison of the operating profit margins for the past 5 years and the most recent quarter:

Company

2009

2010

2011

2012

2013

Q4 2013

Q1 2014

Lab Corp of America

19.94

19.56

17.11

18.05

17.06

14.96

Quest Diagnostics

18.23

17.58

13.35

16.27

20.64

15.36

Bio-Reference Labs

10.57

10.56

10.7

12.39

11.46

10.64

3.24

*Bio-Reference's Q1 for fiscal year 2014 ended 1/31/2014



At this point, Bio-Reference Labs' margins have had the biggest reduction. After growing revenue 20 percent for 19 years through 2012, the CEO now estimates growth of 10 percent for 2014. Earnings were only $0.11 per quarter-over-quarter for Q1 2014, nearly a 65 percent drop from theQ1 2013 earnings of $0.31. $0.05 of the reduction was estimated as being due to the weather, and the rest of the reduction was attributed to lower Medicare reimbursements.

While both Lab Corp of America and Quest Diagnostics have been able to better maintain their margins, their numbers do not include January of this year. Lab Corp's and Quest Diagnostics' earnings are scheduled to be released on April 25th and April 24th. Analysts on average are estimating Lab Corp's earnings to be down 7.5 percent and Quest Diagnostics' earnings to have no change from Q1 2013.

In conclusion, with the lower margins and slower growth rate, Bio-Reference Labs is currently overvalued until they can show margin expansion. Entering the new estimated growth rate of 10 percent into GuruFocus.com's DCF calculator, the fair value is now at $24.34, below today's closing price of $27.27. I would wait until the next earnings announcements to see if Lab Corp of America and Quest Diagnostics can navigate through the Medicare headwinds.

This article first appeared on GuruFocus.

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