LabCorp Fighting Industry Headwinds

By Ryan C. Fuhrmann | April 12, 2012 AAA

LabCorp (NYSE:LH), along with a main rival, control a high percentage of the domestic lab testing market. One would think this dominance would translate into solid growth potential, but challenging industry conditions could keep overall growth constrained going forward.

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First Quarter Recap
Revenues advanced 4% to $1.4 billion. Management attributed the increase to 2.8 percentage points of volume increases and 1.2 percentage points of higher pricing, or revenue per requisition. About 41% of LabCorp's tests stemmed from higher margin genomic, esoteric and related revenue. It has a goal to boost this to 45% of sales within the next five years.

Cost controls helped send operating income up by nearly 22% to $287.1 million. This represented a solid operating margin of 20.5% of revenues. Lower interest expense helped send net income up by 27.1% to $161.6 million, or $1.63 per diluted share. Backing out some costs management felt were not recurring or reflective of its underlying operations, adjusted earnings were $1.74 per diluted share and up 14.4% from last year's first quarter. Free cash flow declined 12.4% to $162.9 million to slightly exceed reported income.

SEE: Understanding The Income Statement

Outlook and Valuation
For the full year, LabCorp said to expect revenue growth of between 2 and 3.5%. Analysts currently project top line growth of about 3% and total revenues just shy of $6 billion. Looking at the competitive landscape, Quest Diagnostics (NYSE:DGX) will log a similar level of sales growth and total sales of nearly $8 billion. Smaller rivals include Bio-Reference Labs (Nasdaq:BRLI) and Medtox (Nasdaq:MTOX), both of which are projected to report double-digit sales growth and total sales of $662 million and $119 million, respectively.

The company projects adjusted earnings in a range of $6.75 and $7.05 per share and free cash flow of almost $800 million, or approximately $8 per diluted share. At the current share price of $86.91, the forward P/E is 11.5 and forward free cash flow multiple is 11.

The Bottom Line
LabCorp pegs the total U.S. lab testing market at $55 billion, giving it a market share of above 10%. Combined with Quest, these two largest players control a quarter of the market. Hospitals including HMA (NYSE:HMA) and HCA (NYSE:HCA) collectively dominate most of the rest of the market.

The consolidated market is making it difficult for LabCorp to grow as rapidly as it once was. Additionally, it is feeling pressures from large health insurers and the government, both of which are using their clout to drive down pricing. These tough operating conditions will likely keep growth constrained, but LabCorp remains firmly profitable and a generator of tons of annual free cash flow.

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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

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