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|Quest Diagnostics Inc. |(DGX-NYSE) |$101.49 |

Note: More details to come; changes are highlighted. Except where noted, and highlighted, no other sections of this report have been updated.

Reason for Report: Flash Update: 1Q18 Earnings Results

Prev. Ed.: Feb 26, 2018; 4Q17 Earning Update

Flash Update [Note: earnings update in progress; final report to follow]

Quest Diagnostics’ 1Q18 adjusted earnings per share (EPS) of $1.52 rose 24.6% from the 1Q17 number.

Reported EPS came in at $1.27, reflecting a 9.5% rise from 1Q17.

Reported revenues in 1Q18 inched up 3.7% year over year (y/y) to $1.884 billion. According to the company, the year-over-year improvement came on the back of successful execution of its two-point strategy of accelerating growth and driving operational excellence.

Volume (measured by the number of requisitions) increased 2.2% y/y in 4Q17. Also, revenue per requisition ticked up 1.6%. Diagnostic information services revenues in 1Q18 rose 4.1% on a y/y basis to $1.80 billion.

Cost of services during 1Q18 was $1.226 billion, up 5.2% y/y. Gross margin came in at 34.9%, reflecting a 100 basis points (bps) contraction y/y.

Coming to operating expenses, selling, general and administrative expenses increased 2.3% to $363 million in 1Q18. Consequently, adjusted operating margin showed a contraction of 60 bps to 15.7%.

Quest Diagnostics exited 1Q18 with cash and cash equivalents of $124 million, which marked a 9.5% decline from $137 million at the end of FY17. Net cash provided by operating activities was $180 million compared with $196 million in 1Q17.

In 1Q18, the company repurchased 0.5 million shares for $50 million. As of Mar 31, 2018, Quest Diagnostics was left with $0.9 billion of authorization under the approved share repurchase plan.

Guidance Intact

Quest Diagnostics has reiterated its FY18 guidance. Excluding the impact of special items, amortization expense and ETB (excess tax benefit associated with stock-based compensation), adjusted EPS for FY18 is projected in the range of $6.50 to $6.70.

Revenues for FY18 are expected in the range of $7.70 billion to $7.77 billion (annualized growth of 4-5%).

Operating cash flow for FY18 is expected at around $1.3 billion. The current estimates for capital expenditure range from $350 million to $400 million.

MORE DETAILS WILL COME IN LATER, IMMINENT EDITIONS OF ZACKS RD REPORTS ON DGX.

Portfolio Manager Executive Summary

Quest Diagnostics Inc. is a leading provider of diagnostic information services and diagnostic solutions in the U.S. The company makes advanced diagnostics solutions available to community physicians through its connectivity solutions, operational footprint and by making complex results actionable.

Of the 18 firms providing ratings on Quest Diagnostics, fourteen (77.8%) assigned neutral ratings, three (16.7%) rendered positive ratings and one (5.6%) firm provided a negative rating.

Neutral or equivalent outlook – 12/17 – As per the neutral firms, Quest Diagnostics’ 4Q17 and FY17 results were in line with estimates as well as the market consensus. The firms believe that organic growth was driven by continued success in non-invasive prenatal testing (NIPT), prescription drug monitoring, TB and Hepatitis C tests. Also, the fact that more than half of the company’s patient service centers are using check-in kiosks is encouraging. This has improved efficiency significantly. The firms also believe that Quest Diagnostics will continue to form partnerships and gain contracts. The firms also believe that the company is on track to achieve its long-term goals. They are encouraged with the company’s strong pace of merger and acquisition activity through FY17, the latest being the closing of the Cleveland Heart Lab and Shiel Medical Laboratory deals in 4Q17. They are of the opinion that the latest buyout of MedXM should strengthen the new set of assets and expand the company’s extended care capabilities. On the flip side, they are concerned about Protecting Access to Medicare and Medicaid Act or PAMA-related headwinds, which can affect revenues in FY18.

Feb 26, 2018

Overview

Quest Diagnostics, Inc. headquartered in Madison, NJ, is one of the largest providers of diagnostic information services in the U.S. The company was spun off from Corning, Inc.’s laboratory testing business in 1996 and has grown primarily through acquisitions and strategic alliances. The company provides information and insights based on routine, non routine and advanced clinical testing, anatomic pathology testing and related services.

The company is currently focusing on infectious disease diagnostic information services and strives to be the first provider of diagnostic solutions for emerging infectious diseases including offerings for Zika, West Nile Virus, SARS and Influenza A H1N1. It also holds a strong position in the neurology diagnostics market. It is one of the largest listed healthcare facilities companies in the market. More information on the company is available at home.html.

The firms identified the following factors for evaluating the investment merits of DGX:

|Key Positive Arguments |Key Negative Arguments |

|Economies of scale, a key competitive advantage in an industry |Pressure on volume owing to difficult macro economic situation and pricing |

|characterized by huge fixed costs, provide Quest with a lower cost |constitute the primary risk for Quest Diagnostics. |

|structure and competitive pricing power. | |

|National level prominence gives Quest Diagnostics a competitive edge in|Quest Diagnostics faces intense competition from LabCorp, which is evident |

|winning new business and adding incremental volumes via opportunistic |from the re-negotiation of contracts with managed care companies at lower |

|acquisitions. |prices. |

|Management’s efforts to improve operations and execution combined with |The company expects revenue per requisition to continue being impacted by |

|the ‘invigorate’ cost cutting initiative are expected to buoy up the |reimbursement pressures. |

|company’s growth performance in the upcoming quarters. | |

NOTE: Quest’s fiscal references coincide with the calendar year.

Feb 26, 2018

Long-Term Growth

With baby boomers moving into Medicare and living longer, Quest Diagnostics is benefiting from continued population growth and favorable demographics.

Esoteric testing business is growing at a faster pace as physician medicine drives demand for advanced esoteric tests. The company currently maintains a sharp focus on providing advanced diagnostic information services. In 2016, it sold its Focus Diagnostics products business and concluded the disposition of Celera products business. In 2015, it contributed its business of central laboratory testing for clinical trials to a joint venture.

The company’s plan to pursue strategic relationships to help accelerate growth is another important part of its long-term growth strategy. Historically, the company has successfully maintained strategic relationships with healthcare providers, public health authorities and consumer-focused entities that have positioned it for growth in the long term. The company is also trying to support population health with data analytics and extended care services.

Quest Diagnostics’ recent strategic collaborations include IBM Watson Health, Optum (a subsidiary of UnitedHealth Group), Safeway and AncestryDNA.

This apart, the company maintains a strategy to grow 1–2% per year through accretive, strategic acquisitions. In FY17, the company announced seven acquisitions which should allow Quest Diagnostics to go beyond its long-term M&A objective of 1% to 2% top-line growth in 2018. Among these acquisitions, the company’s recently-closed buyout of the Cleveland HeartLab from Cleveland Clinic is worth a mention. This lab will be Quest Diagnostics’ advanced diagnostic center of expertise in cardiovascular testing. This apart, the company completed the buyout of shield medical laboratory, which will strengthen its position in the New York metropolitan marketplace.

Late in 2016, Quest Diagnostics came up with a renewed and upgraded long-term growth outlook (beyond 2017) based on its new two-point strategy to generate shareholder value, accelerate growth and drive operational excellence. The company has raised its outlook for the period 2017–2020. It currently expects revenue growth in the range of 3–5%.  Earnings for the same period are expected to grow faster than revenues in the mid-to-high single-digit range. According to the company, its increasing number of partnerships with other health care leaders are creating opportunities for top-line and bottom-line growth while improving patient experience and reducing the overall cost of care.

The company has committed to drive growth and operational excellence. It is also putting efforts to drive digital enablement and margins.

However, the recent change in the political scenario may affect the company’s growth process adversely if the existing ACA gets fully or partially repealed, it may lead to a massive increase in uninsured lives.

Feb 26, 2018

Target Price/Valuation

|Rating Distribution |

|Positive |16.7% |

|Neutral |77.8% |

|Negative |5.6 % |

|Avg. Target Price |$103.69 |

|Maximum Target |$117.00 |

|Minimum Target |$95.00 |

|No. of analyst with target price/Total |13/18 |

|Average upside from current |1.1% |

|Maximum upside from current |14.0% |

|Minimum downside from current |-7.4% |

Risks to the target price include acceleration of pricing competition as a way to gain incremental volumes, slow development of esoteric tests which generate the highest revenue per test, and government reimbursement, which could come under pressure for the next several years.

Recent Events

On Feb 1, 2018, Quest Diagnostics reported its 4Q17 results. Highlights are as follows:

➢ Adjusted EPS in 4Q17 increased 6.9% year over year (y/y) to $1.40.

➢ Reported revenues in 4Q17 rose 4.1% y/y to $1.94 billion.

➢ Quest Diagnostics issued FY18 revenues guidance at the range of $7.7 billion to $7.77 billion, (annualized growth of 4-5%). The company on the other hand expects adjusted EPS to be in the range of $6.50 to $6.70.

Revenues

Quest Diagnostics’ reported revenues in 4Q17 rose 4.1% y/y to $1.94 billion. According to the company, the y/y improvement was driven by the successful execution of its two-point strategy of accelerating growth and driving operational excellence.

New Two-Point Strategy

In Nov 2016, the company updated its existing 5-Point strategy and narrowed its focus to two elements- to accelerate growth and to drive operational excellence. 

1. Restore Growth: The company has adopted seven tactical approaches to accelerate growth, such as sales and marketing excellence; development of esoteric testing through a disease focus; partnerships with hospitals and successful testing of international IDNs; creation of value from information assets; leadership in companion diagnostics; and foray into adjacent markets.

2. Drive Operational Excellence: The company plans to focus on four strategic requirements — to enhance end-to-end customer value chain, enterprise information technology architecture, business performance tools and cost excellence.

As per this outlook, revenue growth for the period 2017-2020 is expected to be 3-5%, with 1% to 2% likely to come from acquisitions. Earnings in the same period are expected to grow faster than revenues in the mid-to-high single digit range. The company currently expects revenue growth for the period 2017-2020 in the band of 3-5%. Earnings in the period are expected to grow faster than revenues in the mid-to-high single digit range. According to the company, its increasing number of partnerships with other health care leaders are creating opportunities for top and bottom-line growth while improving patient experience and reducing overall cost of care.

At the end of FY17, Quest Diagnostics remains confident in achieving the outlined targets through 2020. According to the company, this outlook hints at adjusted EPS of $6.00 to $7.00 by 2020.

Segmental Revenues

Over 90% of Quest Diagnostic’s revenues are derived from diagnostic information services (DIS) with the balance derived from risk assessment services, clinical trials testing, diagnostic products and healthcare information technology. The company is currently the leading provider of DIS, including routine testing, esoteric or gene-based testing and anatomic pathology testing. In addition, the company also offers healthcare organizations and clinicians information technology solutions.

DIS Revenues (95.7% Total Revenue in 4Q17)

In 4Q17, DIS revenues grew 4.5% y/y to $1.85 billion. Volume (measured by the number of requisitions) increased 2.4% y/y.

Recent Developments

On Dec 12, 2017, Quest Diagnostics announced the completion of the acquisition of Shiel Medical Laboratory business from Fresenius Medical Care, the premier healthcare company focused on delivering the highest quality care to people with renal and other chronic conditions.

On Dec 1, 2017, Quest Diagnostics announced the completion of Cleveland HeartLab buyout. This is in line with the company’s plan to establish a national center of excellence in diagnostic information services at Cleveland HeartLab's 25,000-square feet specialized laboratory in Cleveland, OH.

Other Operating Segments (accounting for the rest)

All other operating segments include the company's Diagnostic Solutions (DS) businesses, which consist of its risk assessment services, healthcare information technology and diagnostic products (prior to disposition on May 13, 2016) businesses. The company's DS businesses offer a variety of solutions for life insurers and healthcare providers.

MedXM Buyout

On Feb 1, 2018, Quest Diagnostics announced the buyout of a leading national provider of home-based health risk assessments and related services — Mobile Medical Examination Service (MedXM).

Based in Santa Ana, CA, MedXM has an extensive national network of more than 1,700 medical professionals. It provides enhanced member satisfaction for health plans, particularly Medicare Advantage and managed Medicaid, and also enriched quality of care. Thus, the acquisition will strengthen Quest Diagnostics’ position in extended care and widen its scale and reach in the mobile/home segment as well.

Outlook: Revenues for FY18 are expected in the range of $7.7 billion to $7.77 billion (annualized growth of 4-5%).

The firms expect revenues of $7.74 billion and $7.93 billion for 2018 and 2019, respectively.

Margins

Quest Diagnostics’ cost of services during 4Q17 was $1.19 billion, up 2.9% y/y.

Gross margin came in at 38.3%, a rise of 66 basis points (bps) y/y.

Selling, general and administrative expenses increased 13.3% to $453 million in 4Q17. Adjusted operating margin showed a contraction of 125 bps to 14.9%.

Outlook: For FY18, Quest Diagnostics has not provided any guidance in regard to operating margin.

Earnings Per Share

Adjusted EPS increased 6.9% on a y/y basis to $1.40 in 4Q17 on account of strong top-line growth.

Adjusted EPS in FY18 came in at $5.67, reflecting a 10.1% increase from the year-ago figure.

Outlook: Quest Diagnostics expects adjusted EPS for FY18 in the range of $6.50 to $6.70, excluding the impact of special items, amortization expense and ETB (excess tax benefit associated with stock based compensation).

The firms expect adjusted EPS estimates of $6.65 to $6.85 in 2018 and 2019, respectively.

Feb 26, 2018

|Analyst |Gargi Seth |

|Copy Editor |Parijat Sen |

|Content Ed. |Urmimala Biswas |

|No. of brokers reported/Total |13/18 |

|brokers | |

|Reason for Update |4Q17 Earnings Update |

|QCA |Urmimala Biswas |

|Lead Analyst |Urmimala Biswas |

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