Quest's EPS Beats, Revs In Line

Quest Diagnostics (DGX - Analyst Report) reported EPS of $1.19 in the fourth quarter of fiscal 2011 compared with 97 cents in the year-ago period. However, the reported quarter recorded 2 cents of restructuring and integration related charges, 2 cents associated with CEO succession costs and a benefit of 8 cents associated with discrete tax items. The year-ago quarter recorded charges of 3 cents related to restructuring activities, 3 cents pertaining to a litigation settlement and a benefit of 5 cents associated with discrete tax items.

Adjusting for these one-time items, EPS in the reported quarter came in at $1.23, handily beating the Zacks Consensus Estimate of $1.06 and adjusted EPS of $1.03 in the year-ago quarter. A 7.4% decline in the number of outstanding shares to 157 million favorably impacted the quarterly earnings. For the full year, adjusted EPS came in at $4.53, ahead of both the Zacks Consensus Estimate of $4.29 and the year-ago level of $4.23.

Revenues for the quarter increased 3.0% year over year to $1.9 billion, almost matching the Zacks Consensus Estimate. For fiscal 2011, revenues came in at $7.5 billion, up 1.9% and almost in line with the Zacks Consensus Estimate. The acquisitions of Athena Diagnostics and Celera Corporation contributed 2.2% to revenue growth in 2011.

In the reported quarter, the acquisitions of Athena and Celera contributed 3.2% to revenue growth. Clinical testing revenues increased 2.6% during the quarter with clinical testing volume (measured by the number of requisitions) climbed 1.2%. Revenue per requisition increased 2.2%. After drop in volume for two consecutive quarters, the improvement was encouraging.

Adjusted operating margin in the reported quarter improved marginally to 17.9% on adjusted operating income of $336 million compared with 17.2% in the year-ago period on operating income of $313 million. In 2011, Quest Diagnostics introduced a multi-year $500 million cost-reduction initiative.

Quest exited the quarter with $164.9 million in cash and cash equivalents, down from $449.3 million at the end of fiscal 2010. Cash flow from operations for the year was $338 million compared with $340 million at 2010 end.The company is focused on enhancing shareholder value and improving returns on capital. During the reported quarter, Quest repurchased shares worth $50 million.

During the earnings call, Quest Diagnostics also announced an increase in the company's share repurchase authorization by $1 billion. With this, the current share repurchase authorization amounted to $1.1 billion. In 2011, the company repurchased approximately 17 million shares of common stock for $935 million.

Outlook

Quest Diagnostics provided its outlook for fiscal 2012. The company expects revenues growth of 2%–2.5%. The current Zacks Consensus estimate of 2% growth is at the lower end of the company’ guidance. However, EPS expectation of $4.40– $4.55 is way below the Zacks Consensus Estimate of $4.68. Moreover, guidance for operating margin should be around 18% with $1.2 billion in cash from operations and $225–$250 million of capital expenditure.

Recommendation

We are encouraged by the company’s solid fourth quarter performance and appreciate its strategy of repurchasing shares to drive shareholder value. We are also impressed with Quest’s focus on latent areas such as gene-based, esoteric testing that are currently witnessing higher demand compared to routine tests. In order to bolster this specialized side of the business, Quest has been pursuing accretive acquisitions. The acquisitions of Athena and Celera are expected to strengthen the company’s foothold in gene-based and esoteric testing.

However, the company continues to witness challenges with testing volume. Moreover, the competitive landscape remains tough with the presence of Laboratory Corporation of America Holdings (LH - Analyst Report). LabCorp is scheduled to release its fourth quarter 2011 results on Friday, February 10.

We currently have a Neutral recommendation on Quest Diagnostics, in line with Lab Corp. Both the stocks retain short-term Zacks #4 Ranks (Sell).

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