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Laboratory Corporation of America Holdings (LH - Analyst Report) reported second-quarter 2013 adjusted earnings per share of $1.80. The result was a penny ahead of the Zacks Consensus Estimate and up 1.7% year over year.

On a reported basis, after including amortization (14 cents), restructuring and other special charges (4 cents), LabCorp’s net earnings of $151.9 million or $1.62 per share in the second quarter of 2013 were lower than net earnings of $153.3 million or $1.56 per share in the year-ago quarter.

Quarter Under Review

Revenues improved 3.1% year over year to $1,468.2 million in the second quarter, surpassing the Zacks Consensus Estimate of $1,453 million. Although the company witnessed a 5% increase in testing volume (measured by requisitions), poor revenue per requisition (down 1.8% year over year) reflects a low volume growth environment. Lower healthcare utilization and Medicare payment reductions affected both LabCorp and its peer Quest Diagnostics’ (DGX - Analyst Report) second-quarter results.

Delays and denials of coverage for existing tests by some payers following the implementation of the recently introduced molecular pathology codes, implementation of sequestration on Apr 1, 2013 and growth in the company’s drugs of abuse testing were major dampeners. 

Gross margin declined 139 basis points (bps) to 39.3% in the quarter. Adjusted operating income declined 1.2% year over year to $296.4 million in the reported quarter. This led to an operating margin of 20.2%, down 89 bps from the year-ago quarter. Lower gross margin along with a 1% rise in selling, general and administrative expenses led to a drop in operating margin.

LabCorp exited the second quarter with cash and short-term investments of $111.3 million compared with $466.8 million at the end of 2012. The company had $225 million borrowings outstanding under the $1.0 billion revolving credit facility. Operating cash flow in the quarter was $137.6 million.

During the quarter, LabCorp repurchased 3.7 million shares for $362 million and was left with $592.1 million of authorization under the approved share repurchase plan. A consistent share buyback program led to a 4.4% decline in the outstanding share count and thereby had a positive effect on earnings per share.

Outlook

LabCorp reiterated its revenue guidance for 2013. The company still expects revenue growth in the range of 2%–3%. The Zacks Consensus Estimate of $5,782 million remains within the provided range.

The company trimmed its guidance for adjusted earnings per share to $6.90−$7.10 (including an adverse impact of 35 cents due to Medicare payment reductions) from the earlier range of $6.85−$7.15. The projection does not take into account the positive impact of any share repurchase activity for 2013. The current Zacks Consensus Earnings Estimate of $7.07 is at the higher end of the guidance range.

In addition, guidance for operating cash flow and capital expenditure lies in the range of $825−$850 million (earlier range was $870−$900 million) and $200−$220 million (unchanged), respectively. The updated capital expenditure guidance is higher than the historical levels due to near-term investments in facility consolidation and replacement of a major testing platform. 

Our Take

Although the second-quarter results topped the Zacks Consensus Estimates on both counts, the challenging volume environment for testing laboratories and utilization weaknesses are looming headwinds. Moreover, we are concerned about the Medicare payment reductions, recent-introduced molecular pathology codes and implementation of sequestration. Although the share repurchase activity provided some cushion for the company, the bottom-line results failed to boost confidence.

Nonetheless, LabCorp is continuously working on portfolio expansion and market expansion to drive top line. In April, LabCorp expanded its long-term alliance with Bristol-Myers Squibb Company (BMY - Analyst Report) by signing a new five-year agreement. Under this agreement, Bristol-Myers selected LabCorp Clinical Trials as a preferred provider for the company’s full-service global central laboratory services and biomarker testing.In June, LabCorp formed an alliance with Mitsubishi Chemical Medience Corporation (MCM), toextend service offerings in Japan and worldwide.

In light of these facts and the market overview, we remain on the sidelines for LabCorp. Accordingly, the stock carries a Zacks Rank #4 (Sell).  

While we tread with caution for LabCorp, another healthcare stock such as ResMed Inc. (RMD - Analyst Report), carrying a Zacks Rank #1 (Strong Buy) is worth considering.

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