Quest Diagnostics Beats by a Penny

Quest Diagnostics (DGX - Analyst Report) reported an adjusted EPS of $1.00 during the first quarter of fiscal 2011, a penny above the Zacks Consensus Estimate and the year-ago quarter. Revenues for the quarter increased 1% year over year to $1.8 billion, in line with the Zacks Consensus Estimate. A 10.5% decline in the number of outstanding shares had a favorable impact on  earnings.

The adjusted earnings in the reported quarter excludes the impact of severe weather (7 cents), costs associated with workforce reduction (5 cents) and recent transactions (2 cents) related to Athena Diagnostics and Celera Corporation (CRA). The year-ago period also witnessed the impact of severe weather (5 cents) and restructuring charges (6 cents).

Clinical testing revenues, which account for most of Quest’s sales, increased 0.3% compared to the prior year. While clinical testing volume (measured by the number of requisitions) during the quarter increased by 2% compared with the year-ago period, revenue per requisition was lower by 1.7%. The impact of a severe weather during the quarter reduced revenues and volume by 1.4%.

Adjusted operating margin for the reported quarter declined to 16.3% on an operating income of $301 million compared to 18.1% in the year-ago period on an operating income of $330 million. Higher operating costs and expenses resulted in lower operating margin.

Quest exited the quarter with $994.2 million in cash and cash equivalents, up from $449.3 million at the end of December 2010. Cash flow from operations during the quarter was $161 million, down from $239 million in the corresponding period of last year.

Based on a strong cash balance, the company rewards its shareholders in the form of share buybacks and suitable acquisitions. During the quarter, the company repurchased $835 million worth of common shares.

With the recent acquisition of Athena Diagnostics from Thermo Fisher Scientific (TMO - Analyst Report), Quest is confident about strengthening its presence in the neurology diagnostics market. Moreover, the proposed acquisition of Celera will bolster its cardiovascular testing portfolio.

To fund the acquisition of Athena Diagnostics and to repay a part of its debt, in March 2011, Quest had offered senior notes worth $1.25 billion in four parts. As a result, the long-term debt of the company increased to $3.5 billion compared to $2.6 billion at the end of the fiscal.

Outlook

Quest updated its outlook for 2011. The company expects to report an adjusted EPS of $4.25-$4.45 banking on a 2% growth in revenue (1% growth as per previous guidance). This reflects a 1% increase from the impact of the Athena acquisition.

The company expects operating margin to be around 17.5%−18% (adjusted) and to generate $1.1 billion in cash from operations. In addition, the company expects to incur capital expenditure of $220 million.

Recommendation

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

Based on favorable demographic trends and strong focus, Quest will continue to remain one of the leading players in the industry. However, the macro environment continues to be a major concern and is negatively impacting testing volume.

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

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