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On Feb 7, we upgraded Quest Diagnostics (DGX - Analyst Report) – a leading player in the diagnostic testing market – to Neutral following a decent fourth-quarter 2013. In spite of challenges with testing volume, we are optimistic about the company’s ongoing restructuring initiatives as well as its focus on high potential areas such as core diagnostic information services.

Why the Upgrade?

Quest Diagnostics is witnessing continuous challenges with testing volume. Moreover, lower healthcare utilization and reimbursement pressure from government and other payers continue to pose threats.

However, after several quarters of disappointing performances, amid industry-wide headwinds on reimbursement and utilization, Quest Diagnostics managed to post a decent fourth-quarter 2013, beating on both the top and the bottom line. The quarter’s adjusted earnings per share (EPS) from continuing operations of $1.03 surpassed the Zacks Consensus Estimate by 9.6% and the year-ago earnings by 2%. Although, revenues from continuing operations for the quarter were down 1.0% year over year to $1.76 billion, the figure remained marginally ahead of the Zacks Consensus Estimate of $1.73 billion.

Concerns also linger about a poor 2014 revenue outlook, indicating that the industry trend does not seem likely to improve in the near future. However, we are upbeat about the long-term growth drivers which should reflect positive outcomes with time. With baby boomers moving into Medicare, the company is expected to be benefited from continued population growth and favorable demographics.

The esoteric testing business is expected to grow at a faster pace as physician medicine drives demand for advanced esoteric tests. Despite the slow uptake of the Affordable Care Act, the company expects more insured lives to enter the market each year. Moroever, with newer medical guidelines, the company expects to see increasing uptake of tests like Hepatitis C. Accordingly, over the long haul, we expect Quest Diagnostics, as a provider of low-cost diagnostic information services, to be able to garner more growth in this high-potential but still under-penetrated niche market.

Quest Diagnostics now carries a Zacks Rank #3 (Hold).

Med-Tech Stocks That Warrant a Look

While we prefer to avoid Quest Diagnostics until further signs of improvement in the company's performance, better-placed medical device stocks worth a look are Almost Family Inc. (AFAM - Snapshot Report), DaVita HealthCare Partners Inc. (DVA - Analyst Report) and Addus HomeCare Corporation (ADUS - Snapshot Report). While AFAM holds a Zacks Rank #1 (Strong Buy), DVA and ADUS carry a Zacks Rank #2 (Buy).

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