Earnings Scorecard: Quest Diagnostics

The announcement of Quest Diagnostics (DGX) fourth quarter and fiscal 2010 results on January 25, 2011, has triggered analysts to revise estimates upwards.

Fourth quarter highlights

Quest Diagnostics reported an EPS of 97 cents during the fourth quarter of fiscal 2010, surpassing the Zacks Consensus Estimate of 91 cents although unchanged from the year-ago quarter. Earnings during the quarter included charges associated with workforce litigation and employment reduction, offset by a favorable tax resolution. For the full year the EPS came in at $4.06, ahead of both the Zacks Consensus Estimate of $3.98 and the previous year’s $3.88.

Revenues for the quarter declined 1.3% year over year to $1,824 million, which exceeded the Zacks Consensus Estimate of $1,801 million. Despite a decline in revenues, EPS remained unchanged due to the 7.8% reduction in the number of outstanding shares. For fiscal 2010, revenues came in at $7,368.9 million, down 1.2% from 2009 but surpassing the Zacks Consensus Estimate of $7,346 million.

Clinical testing revenues, which account for most of Quest’s sales, declined 1.4% compared to the prior year. While clinical testing volume (measured by the number of requisitions) during the quarter increased by 0.1% compared with the year-ago period, revenue per requisition was lower by 1.5% but remained in line with the past two quarters.

Quest expected to report EPS of $4.10-$4.30 based on a 1% growth in revenue. However, the earnings guidance was raised following the company’s decision to repurchase 50% of GlaxoSmithKline’s (GSK) holding of 30.75 million shares. As a result, Quest raised its 2011 adjusted EPS guidance to $4.25 to $4.45.

For a full coverage on the earnings, read: Quest Beats, Guides in-line

Agreement of Analysts

Following the release of fourth quarter results, estimate revision trends among depict a favorable bias for the company’s earnings in the forthcoming periods. Over the last 7 days, 11 of the 19 analysts covering the stock have made upward revisions for the first two quarters of fiscal 2011, with no revision in the opposite direction. In the past 30 days, 4 analysts have lowered their estimates for the first quarter of fiscal 2011 with three moving in the reverse.

A similar situation can be witnessed for fiscal 2011. Out of 16 analysts, 10 have raised their estimates with no downward revisions. The recent increase in the company’s guidance following the share repurchase program pushed the analysts to raise their estimates in the past 7 days. However, the quarterly result in the backdrop of a marginally improved scenario also led to upward revision in estimates.

The positive volume growth for Quest came after several quarters of disappointment. While volume improved by 0.1% compared with the year-ago period, it continues to remain under pressure due to general slowdown in physician office visits. However, the fourth quarter volume reflects continued and steady improvement from the first part of 2010. For 2010, volume declined by 1% compared to the previous year. With an 8.2% increase, drugs-of-abuse testing contributed modestly to the improved volume trend.

The company is striving to better manage its cost structure, evaluate a number of new opportunities and bring about quality improvements. To meet these objectives, Quest has made investments in the recent past in sales and service, which are temporarily pressurizing margins. However, over a longer time period, these investments should result in accelerated revenue growth and margin expansion.

To benefit in the long term, Quest is focusing on areas with high potential such as gene-based, esoteric and anatomic pathology testing, which accounted for approximately 36% of the company’s total revenue in 2010. Although the company has been witnessing a decline in revenues derived from anatomic pathology, we are encouraged by the 3% growth of gene-based and esoteric testing during the quarter, driven primarily by sales to hospitals and specialist physicians.

Quest continues to face challenges as its anatomic pathology continues to witness declining revenues. Moreover, the company’s current litigation related to the California Medicaid program is an overhang for the stock.

Magnitude of Estimate Revisions

The magnitude of revisions is modest following the fourth quarter results. Overall, estimates for the next two quarters have gone up by a penny and 3 cents to 98 cents and $1.16, respectively. However, estimates for 2011 have gone up by 12 cents to $4.40.

Our Recommendation

We appreciate Quest’s move of repurchasing shares and paying dividends to drive shareholder value. Besides, the company is adopting strategies such as suitable acquisitions, increased sales force and targeting additional geographies to drive its top line.With positive volume growth during the quarter coupled with stability in pricing, the company is gearing for a gradual recovery. We are encouraged by Quest’s strong portfolio of tests, many of which are finding greater acceptance with time.

We have a ‘Neutral’ recommendation on the stock which corresponds to the Zacks # 3 Rank (Hold).

QUEST DIAGNOSTC (DGX): Free Stock Analysis Report

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