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Quest Diagnostics Incorporated (NYSE:DGX) competes in the diagnostic testing sector of the health industry, in the U.S. and globally.
Since the latter part of 2018 it made a long-term, sustainable upward move in its share price (with the exception of the immediate aftermath of the impact of the pandemic on the company), jumping from approximately $80 per share at the time to a five-year high of $174.16 at the end of 2021. Since then, it has fallen back to a 52-week low of $120.40, and has since rebounded to a little under $150 per share as I write.
In the last reporting period, it experienced headwinds from an ongoing decline in revenues from COVID-19 test kits, Hurricane Ian, and low incremental organic growth.
In this article, we’ll look at some of the numbers from its last earnings report, the loss of revenue from COVID-19 tests, and why organic growth alone isn’t enough to drive the growth of the company going forward.
Some of the numbers
Revenue in the third quarter was $2.49 billion, down 10.4 percent year-over-year. Revenues from base business were $2.17 billion, up 5.1 percent, while revenues from COVID-19 test kits plunged 55 percent to $316 million in the reporting period.
Revenues from diagnostic information services were down 10.5 percent from the third quarter of 2021, also as a result of lower revenue from COVID-19 testing in the same quarter last year.
One positive is the company did do well with revenue growth from its base testing business, even with the headwind it faced from Hurricane Ian in the quarter. Hurricane Ian had an impact of about 30 basis points on the volume growth in the reporting period, according to management.
Overall base testing volumes were up 1.6 percent in the quarter, while organic base testing volumes were up 1.4 percent year-over-year. Even though this points to incremental, organic growth, it’s not, in my opinion, enough to support the current share price where it stands today.
Diluted earnings per share came in at $2.17, a decline of 46 percent from the third quarter of 2021. Adjusted diluted EPS was $2.36, down 40.4 percent from the same quarter last year. Hurricane Ian accounted for about $0.05 of the drop in EPS.
Testing volumes for COVID-19 continued to fall in the third quarter. At the time of its earnings report in October, the number of daily COVID-19 molecular tests volume had plunged to 17,000 per day, and is expected to continue to fall in the quarters ahead. That’s not only significant on the revenue side of the business; they are also a high-margin tailwind for the company, which is why EPS was down so much year-over-year.
The company guided for COVID-19 molecular testing volume to be in a range of 10,000 to 15,000 daily tests in the fourth quarter. How it performs in the fourth quarter will, for the most part, be determined by whether it’s on the low or upper end of its testing volume guidance.
In October, the public health emergency was extended for another 90 days, bringing it to the middle of January. If it ends at that time, reimbursement for COVID-19 molecular testing is going to fall off the cliff, which will have a dramatic effect on the performance of the company in 2023.
Operating income in the third quarter was $392 million, or 15.8 percent of revenue, significantly down from the $652 million in operating income in the third quarter of 2021, which accounted for 23.5 percent of revenue. The major reason for the decline was from lower volume from its COVID-19 tests, combined with investment in its base business. Cash from operations in the third quarter was $1.38 billion, dropping from the $1.75 billion last year in the same quarter.
The company had cash and cash equivalents at the end of the quarter of $700 million, with long-term debt of $4 billion.
Below is the full-year guidance for 2022:
Revenues are now expected to be between $9.72 billion and $9.86 billion. Base business revenues are expected to be between $8.38 billion and $8.45 billion. COVID-19 testing revenues are expected to be between $1.34 billion and $1.41 billion. Reported EPS expected to be in a range of $8.52 to $8.72 and adjusted EPS to be in a range of $9.75 to $9.95. Cash provided by operations is expected to be at least $1.7 billion and capital expenditures are expected to be approximately $400 million.
Growth via acquisitions
As the numbers reinforce in the earnings report, organic growth, while an important component of the performance of DGX, won’t be enough to significantly boost the share price of the company going forward, especially after the prolonged upward move in its share price, starting in December 2018 and ending in December 2021.
Much of the growth was associated with COVID-19 testing, and as that winds down, new revenue streams will have to open up if the company is to enter into a new period of sustainable growth.
To that end, I believe the only way forward for the company to grow in any meaningful manner will be by way of acquisitions.
In that regard, the company did make one acquisition in the third quarter, which was an outreach lab from Summa Health. The company acknowledged it was a small deal, but it pointed to an improving M&A environment, citing financial and labor pressures as a reason for small and large health systems to be more open to talks.
The company noted that it may have more news on M&A in the fourth quarter, suggesting it’s currently working on more deals.
There is no doubt in my mind that the future growth of DGX will have to come from acquisitions if it wants to grab back much of the momentum it had from the high-margin COVID-19 testing volumes. Without that, it’s going to probably continue to grow at an incremental pace in its base business as it continues to lose significant revenue and earnings from COVID-19 testing.
The company said it is investing about $160 million in the third and fourth quarters to market its “new consumer initiated testing platform,” but it’ll take time to find out how much impact it’ll have on revenue and earnings in the quarters ahead. Whatever level of impact it does have, it’s simply not going to be able to offset the revenue and earnings COVID-19 has been delivering to the top and bottom lines of the company.
Again, the point is the way forward for DGX to grow will have to be through acquisitions. That doesn’t necessarily mean it has to always hit home runs, but it does need to tack on some decent businesses that have an impact on the performance of the company.
Conclusion
Taking into account the headwinds DGX faced in the third quarter, it showed some resilience in its performance. It’s likely to get a small boost in its Florida business in the fourth quarter of 2022 and the first quarter of 2023 as it recovers from Hurricane Ian.
On the other hand, it’s going to continue to lose revenue and earnings from its COVID-19 testing business, which won’t be offset by organic growth anytime soon.
For the company to find further support, especially after jumping from approximately $121.00 per share on September 22, 2022, to almost $153.00 on November 10, 2022, it’ll have to find the type of acquisitions that justify that value. With that in mind, I see the stock struggling to maintain its current price range and is probably going to fall into the $120.00 to $130.00 range until there are more catalysts to jumpstart the company. The only catalysts I see that could do that is if continues to make the type of acquisitions that will provide sustainable growth.
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