Our rating on Quest Diagnostics Inc. (NYSE: DGX), a provider of diagnostic testing services, is BUY. Beyond its pandemic response, Quest has entered into numerous agreements to provide diagnostic services at a range of locations, entered a partnership with health insurance provider Anthem, and launched a new product designed for AncestryHealth’s DNA analysis. While we expect a protracted impact from the pandemic, we believe that the company will also continue to take advantage of its position as a leader in diagnostic and antibody testing, while continuing to expand the range and scope of its offerings. On valuation, we believe that DGX is attractively valued at current levels and are reiterating our target price of $135. Our target implies a return of about 13% from current levels, including the dividend, and a P/E of 12-times our 2021 EPS estimate, still below the historical average.
DGX shares have underperformed the market over the past quarter, rising 6% versus a gain of 10% for the S&P 500. However, they have outperformed over the past year, gaining 15% versus a 14% gain for the index. Over the past five years, the stock has risen 80%, below the 93% gain for the index. Quest’s beta is 0.84, below the 1.02 of competitor Lab Corp.
Quest has taken a number of steps in response to the COVID-19 pandemic. On December 17, the company announced a collaboration with The Commons Project, a non-profit public trust, which will help people to access digital versions of their COVID-19 test results and vaccination records. On November 16, it announced a new research study in collaboration with the Dana-Farber Cancer Institute designed to identify the prevalence of COVID-19 in individuals with a precursor to multiple myeloma. The study noted that this population may be more susceptible to complications after exposure to COVID-19 or during recovery from the disease. Through this collaboration, Quest Diagnostics will perform SARS-CoV-2 (COVID-19) IgG antibody testing at no cost to study participants through an in-kind donation to Dana-Farber. On October 13, the company announced the launch of a drone delivery program for at-home self-collection COVID-19 tests for single-family homes in Cheektowaga, New York. Created in partnership with Walmart and drone service provider DroneUp, the Cheektowaga launch is the second location in the company’s pilot program and follows a September 22 launch in North Las Vegas, Nevada. On October 5, Quest announced a collaboration with CLEAR, a secure identity company, to integrate COVID-19 test results with Health Pass, a mobile app that connects a person’s verified identity to real-time surveys and temperature checks. The collaboration is intended to provide a touchless coronavirus screening solution on a national scale.
On September 30, Quest launched three new combined COVID-19 and respiratory virus tests, enabling labs to test for COVID-19, as well as for influenza A or B, other viral targets, and even certain bacterial targets. On September 17, the company began offering COVID-19 diagnostic tests online through its QuestDirect platform, increasing the convenience of specimen collection. The company has also partnered with local governments to increase testing capacity, donated materials to increase access for low-income populations, and launched workforce testing services. Quest has grown its testing capacity since the beginning of the pandemic and is now able to conduct 215,000 diagnostic and 200,000 antibody tests per day, with a 2-day average turnaround time for test results.
Quest has grown in part through strategically aligned partnerships and acquisitions. On December 22, the company announced a partnership with Hackensack Meridian Health to enhance the quality and value of diagnostic services to patients and their doctors. Through the agreement, for which financial terms were not disclosed, Quest will manage laboratory operations and perform reference testing for 11 Hackensack Meridian Health hospitals. On December 8, Quest entered a strategic partnership with Ro, a healthcare technology company, in order to add diagnostic capabilities and lab testing to Ro’s vertically integrated primary care platform. Through this agreement, Quest will process all diagnostic tests for Ro patients, with patients able to have blood draws performed in their home through Ro’s integration with Workpath or at a Quest Diagnostics facility. On November 23, the company announced an agreement to provide professional lab services to Montefiore Nyack Hospital and its renal physician practice, Highland Medical Rockland Associates, in Rockland County, New York. The company also entered into a professional laboratory services relationship with Goshen Hospital in Indiana to provide supply chain management expertise in addition to the reference testing that it already provides.
Earlier, on August 17, the company entered a strategic relationship with Anthem designed to improve efficiency in care delivery, reduce costs, and enhance the experience for health care consumers and providers. The new partnership, which Quest believes can help Anthem drive improvements in health care, focusses on consumers in California, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri, New Hampshire, New York, Ohio, Virginia, and Wisconsin. On August 3, Quest announced that it had completed its acquisition of its joint venture partners’ interests in Mid America Clinical Laboratories (MACL), the largest independent clinical laboratory provider in Indiana. It is now the sole owner of MACL’s laboratory in Indianapolis and 50 patient service centers across Indiana. It also provides professional lab management services for 30 hospitals owned and operated by Community Health Network and Ascension St. Vincent in Indiana. Financial terms of the deal were not disclosed.
The company has also grown through the launch of new products.
EARNINGS & GROWTH ANALYSIS
Quest reported third-quarter results that beat both consensus earnings and revenue estimates. This was the company’s seventh consecutive above-consensus quarter for both metrics. On October 22, Quest reported 3Q20 adjusted net income of $4.31 per share, up 145% year-over-year and above the consensus of $3.73. The increase was driven by strong demand for COVID-19 molecular testing as well as improving performance in the base business. Revenue rose 42% to $2.79 billion, and topped the consensus by $79 million. The adjusted operating margin rose to 29.8% from 17.9%.
Quest’s core Diagnostic Information Services business, or DIS, represented about 97% of 3Q20 revenue. DIS revenues rose 44% to $2.71 billion, as volumes increased 20%, reflecting significant demand for COVID-19 testing services. The DIS segment operates under the Quest Diagnostics brand, as well as under the brand names of a range of acquired companies, including AmeriPath, Dermpath Diagnostics, Athena Diagnostics, ExamOne, and Quanum. The company’s Diagnostic Solutions segment (3% of revenue) offers risk assessment services for life insurers and health information technology solutions for healthcare organizations and clinicians. Diagnostic Solutions revenue fell 2% in 3Q20 to $77 million.
Quest continues to manage costs. Total 3Q operating costs rose 26% to $2.07 billion, driven primarily by an increase in the company’s cost of services, although we note that operating costs fell to 74% of total revenue from 84% in 3Q19. Following several months of furloughs, reduced hours, and pay cuts, the company has reversed these steps amid increased demand for testing services. On December 16, the company raised its outlook for the full year 2020. It now expects to post 2020 revenue of at least $9.35 billion, representing growth of at least 21%, up from its earlier estimate of $8.8-$9.1 billion. On earnings, it expects adjusted EPS of at least $10.75, representing growth of at least 64%, raised from its previous estimate of $9.00-$10.00 per share. It also expects cash flow from operations of at least $1.95 billion, up from its previous estimate of at least $1.75 billion, and capital expenditures of $420 million, raised from $400 million.
Reflecting the company’s increased guidance and the strong demand for COVID-19 molecular testing, we are raising our 2020 EPS estimate to $10.80 from $8.22. We are also raising our 2021 estimate to $11.10 from $9.12, which assumes strong growth in the first half of the year. Our long-term EPS growth rate forecast is 9%.
MANAGEMENT & RISKS
Stephen Rusckowski is Quest’s chairman, president, and CEO. He joined the company as president and CEO in May 2012 and became chairman in December 2016. Over the past several years, Mr. Rusckowski has sought to transform the company by refocusing on core diagnostic information services, selling on core assets, improving capital deployment, and simplifying the company’s organization. Prior to joining Quest, Mr. Rusckowski served as the CEO of Philips Healthcare, which became the largest unit of Philips Electronics under his leadership. Mark Guinan has served as Quest’s CFO since joining the company in 2013. Prior to Quest, Mr. Guinan served as CFO for Hill-Rom Holdings Inc.
Risks for Quest include changes in the U.S. healthcare landscape, including pressure on reimbursement rates and potential declines in the insured population. It also faces risks related to the COVID-19 pandemic, including potential strains on health systems and delays in nonessential visits to doctors to avoid potential exposure. Quest could also be hurt by the loss of market share
during a period of industry consolidation.
The clinical testing business is fragmented and highly competitive. Quest competes with other commercial clinical laboratories, hospital-affiliated laboratories, and physician-office laboratories. Its largest commercial competitor is Laboratory Corp. of America (NYSE: LH).
Quest Diagnostics is a leading global provider of clinical diagnostic laboratories and services that help to identify and treat disease and improve healthcare management. The company incorporated in Delaware in 1990; its predecessor companies date back to 1967. Quest is based in Secaucus, New Jersey, employs roughly 47,000 people, and is a component of the S&P 500.
From a technical standpoint, DGX stock recovered strongly from the pandemic selloff in March. It posted a new all-time high less than two months after the start of the downturn and rose further in July. While the stock then retreated, it continued to form a pattern of higher lows and its 50-day moving average remains well above its 200-day. The DGX shares are now trading at a 14-day relative strength index of 50, suggesting upside potential over the next year.
To value the stock on a fundamental basis, we use peer and historical multiple comparisons, as well as a discounted cash flow model. DGX trades at 11-times our 2021 EPS estimate, slightly above the multiple of 10 for peer Lab Corp. but below the company’s five-year historical average of 16. We believe that Quest will benefit over the next year from its new coronavirus tests, increased demand for testing services, and strong cost controls. As such, our rating remains BUY with a target price of $135. Our target price implies a return of about 13% from current levels, including the dividend, and a P/E of 12-times our 2021 EPS estimate, still below the five-year historical average.
On January 5, BUY-rated DGX closed at $121.74, up $0.62.