ORCH Orchid Cellmark (MM)

Leading lab-testing company Laboratory Corporation of America Holdings (LH) reported adjusted EPS of $1.61 (excluding amortization, restructuring and other special charges) for the third quarter of fiscal 2011. The result was higher than the Zacks Consensus Estimate of $1.60 and the previous year's adjusted EPS of $1.58.

Revenues increased 10% year over year to $1,404.5 million, marginally missing the Zacks Consensus Estimate of $1,408 million. Testing volume (measured by requisitions) and revenue per requisition increased 2.1% and 7.8%, respectively.

Gross margin during the quarter declined 80 basis points (bps) to 40.5%. Adjusted operating margin remained almost flat at 20.3% despite a 4.9% rise in selling, general and administrative expenses.

LabCorp exited the quarter with cash and short-term investments of $85.8 million, compared with $230.7 million at the end of December 2010 and without any outstanding borrowing under the $500 million revolving credit facility. Operating cash flow for the quarter was $176.8 million and was reduced by $49.5 million due to the Hunter Labs settlement.

The company has been using its cash balance to make strategic acquisitions as well as reward its shareholders through share repurchases. During the quarter, LabCorp repurchased 1.8 million shares for $152 million and was left with $256.5 million of authorization. The company is in the process of acquiring Orchid Cellmark (ORCH), for which the current tender offer exists till November 4, 2011.

In May 2011, LabCorp had received a request from the Federal Trade Commission (FTC) for some additional information related to the transaction. LabCorp is cooperating with the FTC on this issue. To date, about 87.2% of the outstanding shares of Orchid have been tendered. Orchid Cellmark provides DNA testing services targeted towards forensic investigation and family relationship status on a global basis.

Based on this deal, LabCorp will be able to develop a command over identity testing in the US and also establish its presence in this field in the UK.

Outlook

LabCorp updated its guidance for fiscal 2011. The company now expects a 10.5−11% revenue growth (previous guidance of 9.5−11.5%) resulting in adjusted EPS of $6.28−$6.33 ($6.17−$6.32) in fiscal 2011. In addition, operating cash flow and capital expenditure is expected to be $900 million (excluding Hunter Labs settlement) and $150 million, respectively.

Recommendation

LabCorp has of late put more and more emphasis on specialized testing. Towards this end, the company undertook a number of acquisitions notable among which are Monogram Bioscience (August 2009) and Genzyme Genetics (December 2010). LabCorp has set a target of garnering 45% of its revenues from the specialty business in the next 3-5 years.

Moreover, LabCorp has been reporting growth in testing volume as well as revenue per requisition over the past few quarters. This was possible based on acquisitions, rate increases, test mix shift and increase in test per requisition.

However, the tough competitive landscape is of primary concern, and the leading diagnostic players including Quest Diagnostics (DGX) are all striving for a greater share of the pie in the high-margined, specialized testing business. We currently have a Neutral recommendation on both LabCorp and Quest Diagnostics, which carry the short-term Zacks #3 Ranks (Hold).

 
QUEST DIAGNOSTC (DGX): Free Stock Analysis Report
 
LABORATORY CP (LH): Free Stock Analysis Report
 
ORCHID CELLMARK (ORCH): Free Stock Analysis Report
 
Zacks Investment Research