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ISI Group Initiates Coverage of LabCorp, Quest at Neutral

NEW YORK (GenomeWeb News) – Investment firm International Strategy & Investment Group today initiated coverage of clinical laboratories Laboratory Corporation of America and Quest Diagnostics with Neutral ratings on their stock.

ISI put a price target of $110.50 on LabCorp shares and a price target of $63.00 on Quest's stock.

Analyst Michael Cherny said in a research note that while lab spending accounts for just 2 to 3 percent of all healthcare spending, they influence between 70 and 80 percent of healthcare decisions. As the two largest players in the independent clinical lab space, LabCorp and Quest should benefit from long-term trends, such as an aging population, the increase in coverage from the Affordable Care Act — which should drive up lab tests — and scientific advances that support esoteric testing.

However, reimbursement pressures will continue to weigh on the two companies as healthcare payors continue to cut costs and pressure to reduce utilization "across the entire healthcare continuum" continues, Cherny said.

The reimbursement cuts will hurt all labs in the long term, but LabCorp and Quest's scale should cushion both firms, he added, while consolidation of smaller labs struggling to deal with pricing pressures should also provide a benefit to the two companies. Between the two, LabCorp and Quest have about a 43 percent share of the $24 billion space, Cherny estimated.

LabCorp, he said, has grown its higher-value esoteric testing portfolio at an annualized growth rate of about 7 percent during the past three years, allowing it to compensate for pressures to its growth profile. While revenue growth has seen only low-single digit growth in the past three years, the company has made targeted investments to grow its revenues, "and given the fixed cost nature of labs, these investments should boost revenue growth over the long term, allowing for operating margin expansion, particularly in an improved utilization environment."

He also noted the firm's balanced capital deployment, which has included a "steady mix" of acquisitions and share repurchases, which Cherny anticipates will continue. The strategy, he added, "should allow the company to drive incremental EPS growth."

Still, the current valuation on the stock already reflects these growth opportunities, resulting in his Neutral rating for LabCorp.

Quest's near term, in the meantime, is uncertain as it continues to suffer from volume and pricing challenges. While its strategy is focused on acquisitions to boost revenue growth, "the current negative utilization and reimbursement trends have weighed on the stock in the near term, and we would expect this trend to continue, particularly until we see an improved utilization environment," both in the macro environment as well as from the ACA, Cherny said.

He noted Quest's Invigorate program implemented in 2012 in order to achieve $600 million in annual run-rate cost savings by the end of 2014, but said that his Neutral rating on the company's stock reflects the lack of clarity around the company's return to growth.