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We recently reiterated our Neutral recommendation on Quest Diagnostics (DGX - Analyst Report), the leading providers of commercial laboratory services in North America, with a target price of $61.00.

The company reported adjusted earnings per share (EPS) of $1.18 in the third quarter of 2012, flat year over year and in line with the Zacks Consensus Estimate. Revenues were down 2.9% year over year to $1.85 billion, nominally missing the Zacks Consensus Estimate of $1.88 billion.

The overall soft industry trends leading to low volume growth was a dampener for the company. This low growth rate was primarily due to a challenging volume environment for testing laboratories and utilization weaknesses across the healthcare sector. Low level of employment and slow growth of commercially insured lives will continue to affect the company’s overall growth until the economy rebounds.

This also led the company to lower its fiscal 2012 revenue guidanceto 0.5% (earlier outlook being 1%–2%), indicating that the industry trend will not improve in the near future. The company also lowered the higher end of its EPS guidance to $4.45– $4.55 (previously $4.45– $4.60).

Quest’s peer, Laboratory Corporation of America Holdings (LH - Analyst Report), is also experiencing the brunt of economic challenges as it posted a meager 0.5% volume increase in the third quarter. The reimbursement scenario remain challenging with an impending cut of approximately 5% in the clinical lab fee schedule beginning January 1, 2013.

To overcome these challenges, the company has undertaken several strategies including cost control to drive its bottom line. We are optimistic about the company’s major organizational restructuring, announced in October 2012, to increase operational efficiency and restore growth.

This structural change will replace the company’s existing business structures with two new business groups – Diagnostic Information Services and Diagnostic Solutions, effective January 1, 2013. According to the company, these structural changes will eliminate three management layers representing 400–600 management positions by the end of 2013, thereby making an annualized savings of $65 million.

We are also optimistic that new management, introduced in May 2012, will likely bring in some changes in the key areas of development. In this regard, the current CEO Mr. Rusckowski presented the new Invigorate Plan, which is focused on improving productivity while minimizing costs.

He prefers to re-assess the company’s resource allocation, internal investments, and geographic exposure in order to optimize organic growth. The company also announced a voluntary retirement program which is expected to deliver $40 million in annualized cost savings, a portion of which will be realized in the current fiscal (full amount to be realized at the end of the first quarter of 2013).

We also appreciate Quest Diagnostics’ 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 targeting fold-in acquisitions instead of larger ones to restore top-line growth. Quest carries a Zacks #3 Rank (Hold) in the short term.

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