Lab stocks Quest, LabCorp shine as testing outlook brightens

Tuesday, May 31, 2016

Shares of Quest Diagnostics and Laboratory Corporation of America Holdings have been on a roll as analysts point to improving business trends for the U.S. clinical-lab testing industry stalwarts.

Their share gains have also come as a competitive threat from Theranos, an upstart rival in the sector, appears to have diminished. Next, the shares face a test of their own: an impending Medicare reimbursement decision.

This year, Quest shares have climbed 8.5 percent and LabCorp has risen 3.5 percent, against a 1.4 percent drop for the S&P 500 healthcare sector.

Both established companies have been buoyed by a broad resurgence in medical testing volume - now running up almost 2 percent annually after several flat years, according to William Blair analyst Amanda Murphy.

The industry has had a broad pick-up in volume as a result of more people seeking health care, said Morningstar analyst Debbie Wang.

"We are just seeing a trend that seems to have legs," Wang said.

Analysts also point to moves by investors away from biotech and some pharmaceutical companies, which have been pressured by criticisms over drug pricing and lagged the broader sector this year, to areas of healthcare seen as more immune to such concerns, as also likely benefiting shares of Quest and LabCorp.

The shares have been gaining amid controversy facing Theranos, which has been seen as a potential disruptor in the lab-testing sector by offering less invasive tests, using only a small amount of blood, and low costs.

Since October, when a Wall Street Journal article raised questions about Theranos' technology, Quest shares are up 25 percent, adding $2 billion to its market capitalization, while LabCorp has climbed 15 percent, building $1.8 billion in company value.

"We did have some concerns that (Theranos) could pick away at some profitable business in a way that would not be helpful to either of those companies' long-term growth profiles," said Dave Perkins, a research analyst and co-portfolio manager at Weitz Investment Management in Omaha, a longtime LabCorp owner.

"It certainly hasn't hurt their stock prices that this hard-to-perfectly-handicap risk has become less of one."


Quest and LabCorp process a wealth of diagnostic tests, from routine blood cholesterol exams to specialized genetic ones. Quest posted revenue of $7.5 billion last year, while LabCorp reported $8.5 billion in revenue, helped by its recent acquisition of Covance, which conducts studies for drugmakers.

Momentum in the two companies' shares could falter if a forthcoming U.S. decision on Medicare reimbursement goes against them.

The U.S. government is expected to issue its rule any day on reimbursement for lab-testing services under the Medicare health program for the elderly. Medicare represents about 12 percent of revenue for Quest Diagnostics and 9 percent for LabCorp, according to Piper Jaffray.

If the Centers for Medicare & Medicaid Services keep the initial proposal, which calculates payments without including the higher rates paid to hospital labs, Quest and LabCorp shares could suffer, analysts said.

While more expensive than a few months ago, the shares may not be so pricy from a historical perspective. At 14.8 times next 12 months' earnings estimates, Quest is trading above its three-year average price-to-earnings ratio, but below levels for most of early 2015 and lower than the 16.4 times for the S&P 500 .

LabCorp shares look more attractive on that basis. They trade at 13.9 times forward earnings estimates, still slightly lower than their three-year average.

"The stock looked inexpensive relative to our estimate of the company's intrinsic value," said Perkins, whose firm has added to its LabCorp holdings. "It feels like a pretty stable place to be."


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