Morgan Stanley: Quest Diagnostics Has Balanced Risk-Reward

Quest Diagnostics Inc DGX shares have derated over the last year, as the stock trades only slightly above its closest peer Laboratory Corp. of America Holdings LH, according to Morgan Stanley.

The Analyst

Morgan Stanley analyst Ricky Goldwasser upgraded Quest Diagnostics from Underweight to Equal-weight and increased the price target from $95 to $103.

The Thesis

Quest Diagnostics' balanced growth strategy supports a mid-single-digit growth rate, with tuck-in acquisitions likely to supplement the company's growth profile, Goldwasser said in a Wednesday note. (See the analyst's track record here.)

The diagnostic company's organic growth accelerated from an average of 0.8 percent between 2014-2016 to 1.9 percent in 2017, the analyst said.

Medicare reimbursement cuts represent multiyear headwinds to earnings, Goldwasser said. The impact, which has already been quantified by Quest, is reflected in the share price, she said. Morgan Stanley estimates the reimbursement cut will represent a 90-to-150-basis point annual headwind to Quest's top line, which Goldwasser said will have a pass-through effect on gross profit margin in 2018-2020.

Quest must offset the rate cuts by delivering on annual cost cuts of $75 million to $85 million, the analyst said.

Morgan Stanley revised its estimates for Quest Diagnostics to reflect the new accounting treatment of unpaid tests, guidance on the tax reform benefit and investments and greater volume contribution from acquisitions. While the firm lowered its revenue estimates for the period from 2018-2020, it raised its earnings per share estimates.

"We see upside optionality if UnitedHealth Group Inc UNH adds Quest to its national lab network in 2019, reflected in our bull case."