Quest Diagnostics’ (DGX) disappointing second quarter 2012 results, released on July 19, prompted analysts to slash their estimates for the forthcoming periods, pricing in the challenges currently at play in the commercial laboratory space.
Second Quarter Highlights
Quest Diagnostics reported 4.5% year-over-year growth in adjusted earnings per share ('EPS') to $1.17, lagging the Zacks Consensus Estimate by a penny.
Revenues for the quarter remained flat year over year at $1.90 billion and marginally missed the Zacks Consensus Estimate of $1.93 billion. Both clinical testing revenues and volume (measured by the number of requisitions) inched up 0.7% during the quarter while revenue per requisition remained flat year over year. The overall soft industry trends leading to low volume growth was a dampener for the company.
The company reiterated its EPS guidance of $4.45– $4.60 for fiscal 2012. However, the revenue growth outlook was reduced to a band of 1%–2%, the earlier outlook being 2%–2.5% growth.
For a full coverage on the earnings, read: Poor 2Q for Quest Diagnostics
Agreement of Analysts
With economic uncertainty taking a toll on the company’s performance, estimate revision trend is bearish for the next two quarters as well as the fiscals ahead. Over the last 30 days, 10 of the 16 analysts covering the stock have lowered their estimates for the third quarter of 2012, with only 2 positive revisions. The same trend can be seen for the current fiscal with 10 downward revisions. None of the analysts have raised their estimates for the current fiscal.
Pricing pressure, lower utilization trends and impending reimbursement cuts in 2013 are the major headwinds for Quest Diagnostics. Consequently, the company reported a mere 0.7% volume growth during the reported quarter. Its primary competitor, Laboratory Corporation of America Holdings (LH) clocked a 0.5% decline in organic volume, a disappointment from 1% growth in the first quarter.
While Quest Diagnostics’ revenue per requisition remained unchanged from the year-ago period, reimbursement pressure was offset by favorable test mix and an increased number of tests per requisition, a trend that is expected to continue. The growth in revenue per requisition reported in the first quarter was primarily due to the increased esoteric mix contributed by Athena and Celera. With the completion of one year, these acquisitions did not have any material impact during the reported quarter.
With no significant job growth in the economy or an increase in commercially insured covered lives, the company’s overall volume growth will continue to languish until the economy rebounds. Given the challenging scenario the company narrowed its growth outlook for 2012.
The reimbursement scenario is also challenging with an impending cut of approximately 5% in the clinical lab fee schedule beginning January 1, 2013.Besides, mandatory physician fee schedule will also witness a 2% cut, effective January 1, 2013. Quest Diagnostics derives 12% and 3% of its revenues (based on 2011 figures) from clinical lab fee schedule and physician fee schedule, respectively. With Medicare accounting for approximately $1 billion in revenues, the company’s top line will be adversely impacted by $40–50 million.
Magnitude of Estimate Revisions
With the majority of analysts lowering their estimates for the forthcoming period, the consensus estimate for the third quarter dropped by a couple of cents to $1.18 in the past 30 days. The consensus estimate for fiscal 2012 also witnessed a drop of 4 cents to $4.56 over the last 30 days indicative of market pessimism on the back of sluggish macroeconomic trends.
Neutral on Quest Diagnostics
We remain concerned about Quest Diagnostics as it contends with volume pressure, reimbursement challenges and declining revenue per requisition. This was followed by an overall market pessimism with the analysts scaling down expectations for the future. We do not expect any significant improvement in the situation near term.
Meanwhile, having witnessed these challenges, Quest Diagnostics’ new CEO, Steve Rusckowski, is working on a comprehensive strategic plan to be declared in the fall of 2012. The company has undertaken several strategies including portfolio expansion, and cost control under the ‘Invigorate Plan” to improve its performance. We also appreciate Quest Diagnostics’ current focus on latent areas such as drugs-of-abuse testing, gene-based, esoteric testing for cancer, cardiovascular disease, infectious disease and neurological disorders. The company is targeting fold-in acquisitions instead of larger ones to restore top-line growth.
We have a Neutral recommendation on Quest Diagnostics. The stock retains a Zacks #3 Rank (‘Hold) in the short term.
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