LabCorp Outshines Estimates - Analyst Blog

Leading lab-testing company Laboratory Corporation of America Holdings (LH) reported adjusted EPS of $1.64 (excluding amortization, restructuring and other special charges) for the second quarter of fiscal 2011.

That result was higher than the Zacks Consensus Estimate of $1.62 and the previous year's adjusted EPS of $1.56.

Revenues increased 13.3% year over year to $1,403.3 million, ahead of the Zacks Consensus Estimate of $1,398 million. Testing volume (measured by requisitions) and revenue per requisition increased 4.8% and 8.1%, respectively.

Gross margin during the quarter declined 120 basis points to 41.9%. Moreover, a 31.5% rise in selling, general and administrative expenses led to a 190-basis point decline in adjusted operating margin to 19.9%. LabCorp's interest expense increased 44.8% during the quarter due to a higher debt burden.

The company had raised $925 million in November 2010, primarily to fund the acquisition of Genzyme Genetics. With the acquisition of Genzyme Genetics, LabCorp expects to strengthen its esoteric testing and personalized medicines business.

In April 2011, LabCorp decided to acquire Orchid Cellmark (ORCH) for $2.80 per share in cash or a total of $85.4 million. After taking into account Orchid Cellmark's cash balance LabCorp's net payable comes to $65.6 million. Orchid Cellmark provides DNA testing services targeted towards forensic investigation and family relationship status on a global basis. Based on this deal, LabCorp will be able to develop a command over identity testing in the US and also establish its presence in this field in the UK.

LabCorp exited the quarter with cash and short-term investments of $118.9 million, compared to $230.7 million at the end of December 2010. During the quarter, the company repurchased 0.6 million shares for $60.5 million and was left with $408.5 million of authorization.

Outlook

LabCorp reiterated its revenue guidance (9.5%-11.5% growth) for fiscal 2011. Moreover, its adjusted EPS guidance of $6.17−$6.32 remains unchanged. In addition, operating cash flow and capital expenditure is expected to be $900 million (excluding Hunter Labs settlement) and $150 million, respectively.

Recommendation

LabCorp continues to focus on strategic initiatives to drive growth and profitability. It includes introduction of innovative tests in the genomic/esoteric arena (specifically in the area of cancer), a greater focus on managed care organizations, and aggressive penetration into the hospital market. The company is focusing more on the high margin esoteric testing business, and has set a target of recording 45% of its revenues from this specialty business in the next 3-5 years.

However, the tough competitive landscape is of primary concern, and the leading diagnostic players are all striving for a greater share in the high margin, specialized testing business. In this regard, Quest Diagnostics (DGX) recently acquired Athena Diagnostics, which engages in diagnostic tests for neurological conditions.

We currently have a Neutral recommendation on the stock, which also corresponds to the Zacks #3 Rank (Hold).