Quest Diagnostics (DGX - Analyst Report), a leading player in the diagnostic testing market, is scheduled to release its third quarter 2012 results on Wednesday, October 17, 2012, before the market opens. According to the Zacks Consensus Estimate, the company is expected to earn $1.18 per share on revenues of $1,909 million during the quarter. For fiscal 2012, earnings are expected to be $4.57 on revenues of $7,638 million, as per the Zacks Consensus Estimate.
Second Quarter Recap
Quest Diagnostics reported earnings per share (EPS) of $1.11 in the second quarter of fiscal 2012, up considerably from $1.02 in the year-ago period. The quarter’s earnings included charges associated with restructuring, integration, and CEO succession costs.
Adjusting for these one-time items, EPS from continuing operations came in at $1.17, lagging the Zacks Consensus Estimate by a penny but up 4.5% year over year. The year-ago quarter included charges related to transaction and integration associated with the Athena Diagnostics and Celera transactions.
Revenues for the second quarter remained flat year over year at $1.90 billion but marginally missed the Zacks Consensus Estimate of $1.93 billion. Clinical testing revenues and volume (measured by the number of requisitions) both inched up 0.7% during the quarter while revenue per requisition remained flat year over year. We believe that the overall soft industry trends which led to a lower volume growth were the dampener for the company.
Quest Diagnostics reiterated its EPS guidance of $4.45–$4.60 for fiscal 2012. However, revenue growth outlook was reduced to the band of 1%–2% (earlier outlook being 2%–2.5%). The company also reaffirmed the operating margin guidance at 18% and $1.2 billion as cash from operations. Further, it expected $200 million of capital expenditure compared with previous guidance of $200–$225 million.
Agreement of Analysts
Ahead of the earnings release, we notice a somewhat bullish trend in the estimate revisions. Out of the 16 analysts covering the stock during the quarter, two analysts made upward revisions over the past 7 and 30 days, while no downward revision took place. An exactly similar trend has been witnessed for fiscal 2012.
Although, concerns linger about the soft industry trends due to a decline in physician office visits, the ongoing margin trends and the company’s lower-than-expected fiscal 2012 guidance, the analysts hold a favorable view regarding the company’s recently announced (on October 11, 2012) major organizational restructuring in order to increase operational efficiency and restore growth.
With effect from January 1, 2013, this structural change will replace the company’s existing business structures with two new business groups, Diagnostic Information Services and Diagnostic Solutions. According to the company, these structural changes will eliminate 3 management layers representing 400-600 management positions by the end of 2013 thereby making an annualized savings of $65 million.
The analysts anticipate that this organizational structure developed by the company’s new CEO, Steve Rusckowski will run successfully adding further synergies to the company’s ongoing $500 million restructuring initiative associated with its Invigorate program. They strongly expect these to improve margins in the upcoming quarters.
The analysts are impressed with Mr. Rusckowski’s leadership style along with his key areas of development including operation and execution. The analysts in this regard are of the opinion that Mr. Rusckowski should utilize his experience in operational excellence over a long time.
They are also encouraged with his merger and acquisition decisions and expect this to remain a key area of growth for Quest Diagnostics going forward. They expect capital deployment to continue into the faster-growth esoteric markets. The analysts assume all these endeavors could very well turn around the company’s fortunes going ahead. However, they are waiting for more light on this matter.
Magnitude of Estimate Revisions
The Zacks Consensus Estimate of $1.18 for the third quarter headed south by 2 cents over the last 7 days. For full-year 2012, the estimate of $4.57 was down by 3 cents over the same period.
Barring the second quarter of fiscal 2012, Quest Diagnostics has exceeded estimates in the past four quarters. For the last one year, the company achieved a positive surprise of 7.13% compared to the Zacks Consensus Estimate.
Neutral on Quest Diagnostics
Quest Diagnostics’ recent move for a major structural change is encouraging. We expect the structural changes along with the company’s ongoing $500 million cost reduction plan to enhance its growth opportunities in the longer term. So, it may be a good bet for investors seeking growth over longer term.
However, the current price is not a good entry point for short-term investors as the ongoing issues like weak volume growth, flat pricing, low organic revenue and challenging underlying market conditions may make it to lose some market capitalization in the near term.
Also, we think an income-seeking investor with the perspective of high risk-return tradeoff should not be disappointed with an investment in Quest Diagnostic as the company steadily deploys capital through dividends and share buybacks. In the last reported quarter, the company repurchased 882,000 shares for $50 million and paid a quarterly dividend of 17 cents that yields 1.1% annually.
Besides, the company is adopting several strategies such as accretive acquisitions, increasing sales force and targeting additional geographies to drive its top line. We are also encouraged with the company’s current focus on latent areas such as drugs-of-abuse testing, gene-based, esoteric testing for cancer, cardiovascular disease, infectious disease and neurological disorders.
The company is witnessing higher demand for these tests compared to routine tests. Notably, earlier this month, the company received the U.S. Food and Drug Administration’s (“FDA”) 510(k) clearance for its Simplexa Flu A/B & RSV Direct test, which was developed by the company’s Focus Diagnostics Laboratory and a global technology company 3M (MMM - Analyst Report). Subsequently, Quest Diagnostic launched this test in the U.S.
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 third quarter 2012 results on October 18, 2012.
We currently have a Neutral recommendation on Quest Diagnostics. The company retains a Zacks #2 Rank (short-term Buy rating).