NEW YORK (GenomeWeb News) – Investment bank Goldman Sachs today upgraded shares of Quest Diagnostics and Laboratory Corporation of America, but downgraded Sigma-Aldrich.
In a research note, analyst Isaac Ro upgraded Quest to Buy from Neutral and LabCorp to Neutral from Sell. He downgraded Sigma-Aldrich to Sell from Neutral.
In upgrading Quest and LabCorp, Ro noted anticipated beneficial effects from the Affordable Care Act on clinical laboratories, in general, saying the legislation "will drive share towards low-cost providers" such as Quest and LabCorp. Because ACA mandates coverage for most Americans, more covered lives will enter the healthcare system, resulting in both testing volume growth, as well as revenue growth for Quest and LabCorp.
At the same time, ACA should reduce those firms' bad debt, Ro said.
For Quest, he increased the six-month price target on the company's stock to $67 from $56 and estimated that testing volume to grow 1.2 percent in 2014 and 0.7 percent in 2015 due to ACA, "offset by unfavorable mix shift to insured patients who generate lower revenue per recognition vs. the uninsured."
While revenue in 2014 is anticipated to increase 0.5 percent in 2014 and 0.1 percent in 2015, "lower bad debt will be a key tailwind and lead to higher" operating profit margins, Ro said.
For both Quest and LabCorp, private-paying uninsured patients make up the largest portion of bad debt, and expanded coverage under ACA, resulting in a reduction in the number of uninsured, should reduce bad debt expenses for both companies, Ro said.
He added that in the longer term the advent of entities called accountable care organizations, or ACOs, should also benefit Quest and LabCorp.
ACOs are organizations that seek to improve the quality of healthcare, while simultaneously reducing costs. As ACOs gain popularity, they should drive lab testing away from in-sourced hospital labs — which are higher cost drivers than clinical labs, Ro said — to testing facilities such as Quest and LabCorp.
"It is our view that the rise of ACOs and exchanges will drive share toward the low-cost providers as in-sourced labs and small providers …often charge 2-3x given inferior scale," Ro said.
He also noted key recent changes to Quest management, including a new CEO, Stephen Rusckowski, and a new operating strategy.
"We believe these initiatives will drive improved margins while also affording investors improved transparency, execution, and ultimately management credibility," Ro said.
He cited many of the same factors in upgrading LabCorp and estimated ACA-related testing volume growth of 1.2 percent in 2014 and 0.7 percent in 2015, offset by an unfavorable mix shift to insured patients. Revenues are expected to rise 0.4 percent in 2014 and to be flat in 2015.
He increased the six-month price target on the company's shares to $96 from $83.
Away from the clinical laboratory sector, Ro today downgraded Sigma-Aldrich and lowered the 12-month price target on the firm's shares to $66 from $72.
During Sigma-Aldrich's analyst day meeting last month, management lowered its long-term organic growth guidance to a range of 3 percent to 4 percent from a previous range of 6 percent to 7 percent. Today, Ro said that the guidance remains too high.
He also pointed to the company's new sales force realignment to focus on three key end markets — research, applied, and the company's custom manufacturing and services business unit called SAFC.
Ro said that such changes have risks "given the high-touch nature of the sales channel" and referenced similar realignments made by Life Technologies in the second quarter of 2006 and second quarter of 2012, "where sales force disruptions have had a greater than expected impact to growth," on that company.
He acknowledged that the two companies' customers are not completely similar, but "we believe these examples are instructive of the execution risk that exists when sales channels are disrupted in this industry."
Further, Ro said that Sigma-Aldrich has fewer options to compensate for "slower growth given mature P&L," and that in addition to softer organic growth, potential pricing pressure resulting in part from a challenging funding environment and oversupply in its LED precursor business are expected. He added that the shift to the firm's higher margin e-commerce platform during the next few years is anticipated to decelerate.
Lastly, Ro said that Sigma-Aldrich's LED precursor business, the firm's fastest growth driver, is "likely to disappoint.
In afternoon trading on the New York Stock Exchange, shares of Quest were up 4 percent to $59.81, while shares of LabCorp rose 2 percent to $95.40. Shares of Sigma-Aldrich on the Nasdaq slipped a fraction of 1 percent to $76.65.