The announcement of Quest Diagnostics’ (DGX) second quarter of fiscal 2011 results as on July 20, 2011, has coaxed analysts to revise estimates downwards.
Second Quarter Highlights
Quest Diagnostics reported adjusted EPS of $1.12 during the second quarter of fiscal 2011, a penny below the Zacks Consensus Estimate but higher than last year's $1.07.
Adjusted EPS takes into account $0.10 per share of transaction and integration costs associated with the Athena Diagnostics and Celera transactions. An 11.8% decline in the number of outstanding shares had a favorable impact on earnings.
Revenues for the quarter increased 1.5% year over year to $1.9 billion, in line with the Zacks Consensus Estimate. The two acquisitions contributed 2.5% to revenue growth.
While clinical testing volume (measured by the number of requisitions) during the quarter decreased 0.9% compared with the year-ago period, revenue per requisition increased 1.6%. This is significant since Quest Diagnostics has been recording lower revenue per requisition over the past four consecutive quarters.
For a full coverage on the earnings, read: Quest a Penny Short, to Cut Costs
Agreement of Analysts
Clinical testing revenues, which account for over 90% of total revenue, increased 1% compared to the year-ago quarter. However, before the contributions from Athena and Celera, the revenues stood short by 1.5%. But clinical testing volume dropped by 1%, which is really disappointing after last two quarters of prominent growth.
Quest has witnessed softness in physician office visits that led to this slide in volume. Volume in May was particularly weak, while April and June were modestly positive compared to the year-ago quarter. In this scenario, Quest expects a 1.5% growth in revenues compared to its previous guidance of 2% rise. The revised guidance takes into consideration the acquisitions of Athena and Celera.
Consequently, analysts also reduced their estimates following lowering of guidance by Quest. Over the last 7 days, 13 of the 20 analysts covering the stock have lowered their expectation for the third quarter of fiscal 2011, with no upward revision. Maintaining the same trend, 14 analysts lowered their estimates for fiscal 2011.
The company lowered the higher end of its adjusted EPS expectation range by 10 cents to $4.25–$4.35. Meanwhile, Quest now expects adjusted operating margin to be around 17.5% (previous guidance of 17.5%−18%) and to generate $900 million in cash from operations (after considering the MediCal settlement). In addition, the company lowered its capital expenditure guidance by $20 million to $220 million.
Apart from a decline in volume, Quest continues to face challenges as its revenues from anatomic pathology have been falling driven by in-sourcing of the tests by physicians. This is significant as this high-margin business generates about 14% of the company’s total sales.
Besides, the company has adopted a number of cost control initiatives that will enable it to meet its previously announced earnings guidance despite a reduced revenue outlook for 2011.
These actions are expected to result in a $20 million charge, to be recorded in the third quarter. Additionally, Quest announced another cost reduction plan to prepare for upcoming growth opportunities. The company aims to reduce its cost structure by $500 million over the next 3 years, targeting a 20% operating margin.
Magnitude of Estimate Revisions
The magnitude of revisions is significant following the second quarter results. Over the past 7 days, estimates for the third quarter have gone down by 3 cents to $1.13. Estimates for fiscal 2011 also witnessed a decline of 8 cents to $4.24 over the last week.
Our Recommendation
While clinical testing volume during the quarter decreased 0.9%, revenue per requisition increased 1.6%. This is significant since Quest has been recording lower revenue per requisition over the past four consecutive quarters.
The drop in volume, however, came as a disappointment after recording growth over the past two quarters. The company also announced a cost reduction plan to effectively tap growth opportunities.
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 and expanding its sales force to drive its top line.
We are encouraged by Quest’s strong portfolio of tests, many of which are finding greater acceptance with time. However, the company faces strong competition from players like Laboratory Corporation of America Holdings (LH), among others.
We have a Neutral recommendation on the stock.
About Earnings Estimate Scorecard
Len Zacks, PhD in mathematics from MIT, proved over 30 years ago that earnings estimate revisions are the most powerful force impacting stock prices. He turned this ground breaking discovery into two of the most celebrating stock rating systems in use today. The Zacks Rank for stock trading in a 1 to 3 month time horizon and the Zacks Recommendation for long-term investing (6+ months). These “Earnings Estimate Scorecard" articles help analyze the important aspects of estimate revisions for each stock after their quarterly earnings announcements. Learn more about earnings estimates and our proven stock ratings at http://www.zacks.com/education/
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