It's no secret that Americans are pretty voracious consumers of health care.
Health care accounts for more than 17% of GDP, and the sector is projected to grow to 20% of the U.S. economy within eight years. A good chunk of the sector is diagnostic laboratory testing, now about a $60 billion industry in the U.S.
Currently, hospitals and health care networks do most lab tests, ranging from routine blood and urine screens to more time-consuming, complex cancer and genetic tests. However, health care providers are now much more likely to outsource lab tests, particularly the more complicated ones, because it's often cheaper and more efficient.
Typically, health care providers want a large, reputable lab with many accessible locations. They certainly prefer a lab that can handle volume that is likely to grow substantially, thanks to the Affordable Care Act (aka Obamacare).
Obamacare, which emphasizes preventive testing, is expected to bring an estimated 25 million new patients into the health care system during the next 10 years. What's more, the enormous baby boom population will likely need all sorts of diagnostic tests as they age. (My colleague Joseph Hogue explored this trend in his "Graying of America" series last summer.)
These trends hold plenty of profit potential, and there's one particular company I think is in the best position to capitalize. As you might expect, it's an industry leader, currently generating $5.8 billion of annual revenue and earnings per share (EPS) of $6.07.
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I especially like this company's growth strategy of increasing its offerings of more complex diagnostic tests that health care providers are likely to outsource. Such tests are typically more profitable because they're reimbursed at higher rates than routine tests.
This company also plans to grow through acquisitions and joint ventures and by continually investing in software that helps improve customer loyalty. It has been implementing innovative cost-cutting measures, too.
I'm referring to Laboratory Corporation of America (NYSE: LH), which operates 1,800 lab test centers and holds about 20% of the independent lab test market.
Among LabCorp's latest offerings of the more complex and profitable variety is a new FDA-approved breast cancer test that helps predict the likelihood of recurrence years down the road in postmenopausal women treated for breast cancer. Clinical studies have found the new test more accurate and informative than previous tests designed for the same purpose.
One of LabCorp's newest genetic tests is the chromosome SNP microarray, which can be used to detect chromosomal changes associated with autism and other developmental problems in children. LabCorp also recently announced the nationwide availability of its KRAS mutation test doctors for identifying patients with colorectal cancer who would benefit from a particular form of treatment. The company has also recently launched non-routine diagnostic tests for use in a variety of other areas such as diabetes, HIV and reproductive issues. In all, LabCorp has about 4,000 routine and more complex diagnostic tests.
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While LabCorp creates many of its own tests, acquisitions have yielded others. In June 2012, for example, the company bought Medtox Scientific, a maker of specialized tests for employment drug screening, forensics and pharmaceutical clinical trials. A year earlier, Clearstone Central Laboratories was acquired for its expertise with lab tests that evaluate medications in the late stages of development. Management recently inked a multi-year deal with genetic research firm Illumina (Nasdaq: ILMN) to use Illumina products to develop new lab tests.
To foster customer loyalty, LabCorp provides online interfaces for managing lab test information. One of the newest is LabCorp Beacon, a Web-based system for ordering tests, viewing and sharing results, and analyzing trends in the results. Test Menu, another online tool, is a searchable directory of all LabCorp tests.
To help boost the bottom line, the company has been trying to reduce its paid workforce by increasing automation. Last September, for instance, the company completed an automation project at its Burlington, N.C., center, where robots now do the repetitive test sample splitting and sorting previously done by people. Management has set a goal of completely automating these functions in its Atlantic division by the end of July.
Another boon to profitability is that LabCorp minimizes less profitable managed-care contracts in which the amount that can be charged for lab tests is capped. Guarantees of higher business volume can make such contracts tempting, but LabCorp hasn't allowed itself to fall into this trap and has limited capped managed-care contracts to around 3% to 4% of total revenue for many years.
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Risks to Consider: About 15% of revenue is from lab tests paid for by Medicare, meaning LabCorp has substantial vulnerability to pricing pressure from the government. Also, greater proliferation of high-deductible health plans could hinder lab test demand by placing more of the cost burden directly on patients, who may then sometimes opt to skip recommended tests.
Action to Take --> Based on the trends and LabCorp's leading position in its industry, I think the company stands to generate some nice profits in coming years. Indeed, EPS should climb an average of 10% a year, hitting $9.78 in five years. Assuming a price-to-earnings (P/E) ratio in the stock's historical range of 16, the stock price could reach $156 per share in 2019, which would be good for a 71% gain from the current price of around $91. With a current P/E of 15, LabCorp is a good value -- and a smart buy -- right now.