Quest Diagnostics: Looking at the Bigger Picture

Quest Diagnostics (NYSE: DGX  ) has been hit by flat to declining sales for two consecutive years now. The company reported a top-line decline of 3.2% for fiscal 2013 to $7.1 billion, while its adjusted income from continuing operations tumbled 8.3% to $4.00 per share. In the first quarter of 2014, the company reported revenue of $1.75 billion, a 2.3% year-over-year decline, while its adjusted earnings shrank 5.6% to $0.84.

The company's close peer Laboratory Corporation of America Holdings (NYSE: LH  ) , had a modest year in 2013. Its revenue improved 2% to $5.8 billion, and adjusted EPS edged up 2% to $6.95. In the first quarter of fiscal 2014, however, things got worse for Lab Corp after the company recorded dismal results with a 1% revenue drop to $1.43 billion and adjusted EPS down 13% to $1.51.

Both companies blamed inclement weather for their latest run of disappointing results, and we want to see more growth from these investments in the longer term.

So, where is the growth going to come from?

BRCA  testing
Quest Diagnostic investors have been optimistic that the company will soon tap into the lucrative breast cancer genetic (BRCA) testing that was pioneered by Myriad Genetics (NASDAQ: MYGN  ) by offering cheaper tests. But the BRCA reimursement rollercoaster by the Centers for Medicare & Medicaid Services (CMS), has left investors a bit confused. BRCA tests are used to screen for gene mutations, which can indicate an elevated risk of the person developing breast or ovarian cancer.

It's a big potential market, since about 230,000 people (mostly women) are diagnosed with breast cancer in America each year, and another 22,000 with ovarian cancer.

Myriad Genetics made $460 million, or 75% of its revenue, from BRCA testing in fiscal 2013, for which it charges $3,340. Quest Diagnostics hoped to undercut Myriad Genetics by charging $2,500 for the service, a strategy that seemed like a sure-fire way for its service, launched in 2013, to quickly gain traction.

CMS delivered a shocker when it announced that it would drastically cut reimbursements for BRCA testing from $2,795 to $1,438. Although CMS later reneged and agreed to raise its BRCA reimbursement to $2,184, the new reimbursement plan was still well below Quest Diagnostics' $2,500 price for the test.

Lab Corp. also introduced its BRCA test known as BRCAssure in December 2013.

Smaller, more nimble players
After this came a flurry of smaller players with much cheaper BRCA tests. Ambry Genetics announced that it planned to sell BRCA test kits for $2,200. Gene by Gene followed suit and announced that it planned to sell its BRCA test panel for just $1,000.

Myriad Genetics has been active in responding to what it believes are patent infringements, and it succeeded in delaying Gene by Gene's test by two years in February. Although these legal antics have succeeded into cowing some smaller players such as Genome Liberty and Pathway Genomics into keeping away from the BRCA testing business for fear of lawsuits, others like Invitae, GenDx, and Counsyl remain undeterred and are still embroiled in court battles with Myriad.

However, it's not entirely inconceivable that Quest Diagnostics will move to acquire at least some of the numerous smaller genetic BCRA testing companies that might impede its own efforts in the field. After all, Quest Diagnostics has been seeking new growth paths through acquisitions. The company acquired Focus Diagnostics for $185 million in 2006, Hemocue for $420 million in 2007, and Ameripath for $2 billion in 2007.

Quest  recently acquired Summit Health, a leading provider of on-site prevention and wellness services, for an undisclosed sum in April this year. A 2012 study by RAND Corp. found that 85% of large organizations with more than 1,000 employees offer a wellness program. The Summit acquisition will boost Quest Diagnostics' own wellness program offerings.

Quest Diagnostics also completed the acquisition of Solstas, a full-service commercial lab, in March this year for $575 million. The company  raised its revenue growth guidance for the current fiscal year from an earlier guidance of 0% to down 2% to growing by 2%-4% immediately after completing the acquistion.

Wide service portfolio
In any case, Quest Diagnostics has a much bigger service portfolio than Myriad Genetics. If Quest Diagnostics' BRCA testing service fails to gain enough traction or faces excessive pricing pressure from rivals, the company will hardly be in any danger of sinking.

Apart from gene-based testing, Quest Diagnostics offers drugs-of-abuse testing, anatomic pathology services,esoteric testing, and specialty products such as DxSelect IFA, HerpeSelect HSV serology, and various ELISA products for testing infectious diseases.

Shares of Quest Diagnostics and Lab Corp. have rallied nicely since their December plunge (due to the CMS reimbursement drama). Quest Diagnostics' shares, however, are a little cheaper than Lab Corp's.

Foolish takeaway
Investors seem to have come to terms with the fact that both Quest Diagnostics is an entrenched industry player in a highly viable and dynamic industry. The company is fully capable of weathering most  industry-related storms better than its competitors, and is a good investment.

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