Quest Diagnostics (DGX) is selling off after reporting quarterly results on Monday morning, and the reason being revenue came in a little lighter than analysts hoped. Consensus expectations called for $1.87 billion in sales but the actual results were just below that target at $1.85 billion. The top-line did grow by 2.7% over a year ago, but the volume of tests performed was down .3% reflecting slower demand for drug testing due to the sluggish labor market. When excluding drug-and-abuse testing, test volume improved by .5%. The company was able to improve margins through cost reductions, and EPS came in at $.97 which topped analysts’ estimates by just a penny.
As Quest Diagnostics closed out fiscal 2009, they offered EPS guidance for fiscal 2010 in the range of $4.10 to $4.30, which was exactly in line with consensus analysts’ calls for $4.20 of profit in the year ahead. The stock is trading 2.5% lower in early afternoon trading, which gives a forward looking P/E multiple of 13.7x, which is just about what we consider normal
in this market especially for a company who has seen growth stall of late. The company is growing earnings at a faster rate than revenue which tells us the company is becoming more efficient and cutting out unnecessary costs. If Quest was able to surprise with better than expected top-line growth, the bottom line would really surge in this leaner company. If hiring does see an upswing it could nicely supplement profitability, in addition to the company’s growth in gene-based, esoteric tests and cancer diagnostics which carry better profit margins.
At Ockham, we are reiterating our Undervalued stance on Quest Diagnostics as of this week’s report. This stock has been beaten down recently falling more about 7% in the second half of last week and today, and we can understand that revenue growth was less impressive than the market would have liked. With that said, the market is valuing Quest more conservatively than what we would consider normal based on historical analysis. For example, over the past ten years (with the most recent years weighed more heavily) DGX has normally traded between1.55x and 2.18x revenue per share, but the current price-to-sales ratio is only 1.43x. Similarly, price-to-cash earnings is currently 12.1x, which falls well below the historical range of 13.4x and 18.9x.
The company authorized an additional $750 million for share repurchases which shows they think the stock is attractively priced. Based on the current fundamentals, which are consistent if not sexy, we would consider a price of $65 to $75 as fairly valued. The market gets the jitters whenever a company comes in light on revenues, but the stock is not expensive even when factoring in the lackluster sales totals. In addition, earnings rose by 20% in the past year and are expected to high single digits in the year ahead. We like the profitability trends for Quest Diagnostics, and would think this stock is priced attractively for a long term investor.
