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LabCorp Reaffirmed at Neutral

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We recently maintained our Neutral recommendation on Laboratory Corporation of America Holdings (LH - Free Report) , the second largest independent clinical laboratory company in the U.S., with a target price of $88.00.

LabCorp’s third quarter 2012 net earnings came in at $148 million or $1.53 per share, higher than $134.3 million or $1.31 per share in the year-ago period. However, after taking into account amortization, restructuring and other special charges, adjusted earnings of $1.76 per share in the reported quarter surpassed the Zacks Consensus Estimate by a couple of cents, and was also higher than the adjusted earnings of $1.61 in the third quarter of 2011.

Difficult economic scenario continued to adversely affect LabCorp. Revenues increased 1.1% year over year to $1,419.4 million, but were way below the Zacks Consensus Estimate of $1,440 million. Although the company reported a year-over-year increase of 3.1% in volume during the reported quarter, organic volume growth was a mere 0.5%.

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 is reflected by the disappointing performance in the quarter that led the company to reduce the upper end of its growth outlook for 2012 to 2.5% (previous guidance of 2−3% revenue growth) resulting in adjusted earnings of $6.88−$6.93 ($6.80−$7.00) in the said fiscal. In addition, guidance for operating cash flow and capital expenditure were lowered to $915 million ($950 million) and $145 million ($155 million), respectively.

However, we are encouraged with the strong portfolio of LabCorp to drive growth. The company is also working to expand its portfolio in the new swab family of tests that allows performing various women's health tests from a single-collection swab. In August, the company finished and published a clinical study for the development and validation of a PCR Assay for the diagnosis of Bacterial Vaginosis.

This Bacterial Vaginosis test is currently available as part of the NuSwab series of tests. Besides, in the same month, LabCorp seconded the Centers for Disease Control and Prevention (CDC)for revisingthe hepatitis C virus(HCV) testing guidelines that suggested (HCV) testing in all people born between 1945 and 1965.

LabCorp recorded approximately 40% of total revenues during the last reported quarter from the genomic, esoteric and anatomic pathology categories, which is expected to go up to 45% over the next 3−5 years. The esoteric volume during the quarter increased 2.2% on the back of decent growth in specialized endocrinology and coagulation businesses, cardiovascular and chronic kidney disease programs.Given the continuous focus on portfolio expansion, we are confident about the company garnering higher revenues from specialized testing, going forward.

Moreover, LabCorp is also paying due attention to strategic acquisitions to grow further, The recent being the acquisition of Medtox Scientific that will help strengthen the company’s foothold in specialized toxicology testing. Some of the other recent acquisitions include Orchid Cellmark, DCL in Indiana, Westcliff Medical Laboratories in California, where LabCorp has limited presence, and Genzyme Genetics in the area of esoteric testing and personalized medicine business. We are also encouraged with the company’s stable liquidity position to successfully complete large acquisitions. LabCorp’s efforts to reward shareholders through share buybacks also encourage us.

However, LabCorp faces intense competition from its major competitor, Quest Diagnostics (DGX - Free Report) , and other commercial laboratories and hospitals.LabCorp is also exposed to the reduction in clinical and physician lab fee schedule, effective January 2013. LabCorp carries a Zacks #4 Rank (Sell) in the short term.

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