Earnings Preview: Quest Diagnostics - Analyst Blog

Quest Diagnostics (DGX) is scheduled to release its fourth quarter and fiscal 2010 earnings on January 25, 2011 before the market opens. The company is expected to earn 91 cents during the quarter on $1,801 million in revenues and $3.98 during the fiscal on $7,346 million in revenues, according to the Zacks Consensus Estimate.

Previous Quarter Highlights

Quest Diagnostics reported an EPS of $1.13 during the third quarter of fiscal 2010, surpassing the year-ago quarter's $1.02. However, excluding a $0.08 benefit associated with a favorable tax resolution, the EPS came in at $1.05, ahead of the Zacks Consensus Estimate of $1.00.

Revenues for the quarter declined 1.7% year over year to $1,865 million, driven by continued softness in physician office visits, and met the Zacks Consensus Estimate. However, EPS improved over the year-ago period due to the 6.9% reduction in the number of outstanding shares.

Clinical testing revenues, which account for most of Quest Diagnostics' sales, declined 1.7% compared with the prior year. While clinical testing volume (measured by the number of requisitions) during the quarter declined 0.3%, revenues per requisition were lower by 1.3% compared with the year-ago period and remained unchanged sequentially.

Following third quarter results, Quest Diagnostics revised its outlook for 2010. The company increased the low end of its previous EPS (from continuing operations) guidance by $0.05 to $3.95–$4.00. However, revenues are expected to decline by 1.5% compared with the earlier projection of a 1% decline.

Agreement of Analysts

Estimate revision trends among the analysts have been insignificant within the last 30 days. Only 1 analyst has lowered his or her estimate for both the fourth quarter and fiscal 2010. No such revision has taken place within the past 7 days.

During the second quarter of fiscal 2010, Quest Diagnostics extended contracts with some managed care operators (MCO) at lower prices, which led to a 0.3% decline in revenue per requisition. As contracts have been extended beyond 2012, no significant contract is left for renewal in the near future.

Consequently, we do not expect any significant decline in prices although testing volume remains the major area of concern. Clinical testing volume has been declining for the past few quarters primarily driven by a general slowdown in physician office visits (leading to lower lab test utilization).

In order to tide over the current crisis, Quest Diagnostics has been undertaking several initiatives which included controlling its cost structure and expanding its sales force. The company has increased its sales force by 100 representatives, providing them with training programs in various subspecialty areas including oncology and genetic testing. We expect an update on the testing mix following the sales force initiatives.

Revenues derived from anatomic pathology have been under pressure for the past few quarters driven by in-sourcing of the tests by physicians. Many health plans have made reimbursement policy changes to address over utilization caused by in-sourcing of certain kinds of anatomic pathology testing.

Although in-sourcing has witnessed some leveling-off during the third quarter, it continues to be a major issue as the company derived 16% of total revenues from anatomic pathology during fiscal 2009. Further improvement in this trend should lead to better volume for the company. Clarity regarding future landscape will be available from the company's guidance for 2011.

Magnitude of Estimate Revisions

The magnitude of revisions is modest following third quarter results. Overall, estimates for the fourth quarter have gone down by a penny to the current level of 91 cents per share in the last 90 days. For fiscal 2010, estimates have slipped by the same magnitude to the current level of $3.98 per share over the past 3 months.

Surprise

Barring the first quarter of fiscal 2010, Quest Diagnostics had exceeded estimates in the past four quarters. However, the company has a marginally negative four-quarter average of 0.55%. This means that on an average, Quest Diagnostics has missed the Zacks Consensus Estimate by 0.55% over the last four quarters.

Our Recommendation

We appreciate Quest Diagnostics' move to repurchase shares and pay dividends to drive shareholder value. Besides, the company is adopting strategies such as suitable acquisitions, increased sales force and targeting additional geographies to drive its top line.

Although the near term volume and pricing outlook will continue to remain under pressure, we believe the company is well placed to bounce back with a gradual improvement in the economic scenario. Moreover, competition in the diagnostics space has intensified further following the acquisition of Genzyme Genetics by LabCorp (LH). This transaction is expected to strengthen LabCorp's esoteric testing business.

We currently have a Neutral recommendation on Quest Diagnostics which is also supported by the Zacks #3 Rank (Hold).

 
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