After hitting its 52-week low in April, Quest Diagnostics (NYSE:DGX) has seen its stock recover nicely, even beating the S&P 500 year to date. This diagnostic giant has been processing many tests for COVID-19 but suffered an initial slowdown in its core testing business when the coronavirus pandemic first hit. The stock has continued climbing back up thanks to good news from the company about the recovery in its normal testing business.

But are the signs so positive that the stock is a buy? Let's find out.

Test tube that says COVID-19

Image Source: Getty Images

Recovery in testing volume

On June 3, Quest Diagnostics announced that testing volume in its core business, excluding COVID-19 testing, is recovering faster it had originally expected when it had reported Q1 results on April 22. More importantly, the rebound has been more pronounced in states that have lifted restrictions on business activity.

Quest also noted that it currently performs 100,000 diagnostic COVID-19 tests a day. The company will be able to complete 150,000 tests per day by the end of June. Quest can now offer 200,000 antibody tests for COVID-19 a day using blood samples taken from patients. As of June 1, Quest Diagnostics had reported results on a total of about 3.15 million COVID-19 diagnostic tests and approximately 1.5 million antibody tests.

Earnings guidance

Assuming that overall testing volume continues to increase sequentially, the company now believes that it will report Q2 adjusted earnings per share between breakeven and slightly positive instead of a loss. These projections do not include $65 million in funds that the firm has received under the Emergency Relief Act.

Despite this more favorable short-term outlook, Quest did not establish overall financial targets for fiscal 2020. It still cannot accurately forecast the near-term impact of the COVID-19 virus on its business due to factors beyond its control, including the severity and duration of the pandemic. On March 30, the company had withdrawn its previously announced guidance for full year 2020. Quest had commented that total testing volumes, including COVID-19 testing, fell by more than 40% during the last weeks in March due to a significant reduction in physician office visits, the cancellation of elective medical procedures customers closing or severely curtailing their operations, and the adoption of "shelter at home" policies. 

Low chance of a major reduction in the dividend

Investors who purchase shares can earn over 1.9% if the company continues to pay a quarterly dividend of $0.56 a share. The current yield on Quest's shares exceeds the yield on shares on almost all medium to large healthcare service companies. More importantly, Laboratory Corporation (NYSE:LH), Quest's major competitor, does not pay a dividend. As a result, unlike LabCorp's shareholders, Quest's investors can benefit from the improving testing volume and receive current income.

If operating results continue to improve, it is highly unlikely that Quest will significantly reduce or eliminate its dividend. It's possible that the company could generate at least $190 million in free cash flow for the first half of 2020. Quarterly free cash flow should expand from my projected range of $25 million to $50 million in Q2 if testing volume continues to increase sequentially and the company controls discretionary spending. Due to the high fixed costs of the business, operating margins on additional volume are much higher than the companywide operating margins of 17%. As a result, the free cash flow that the company generates in 2020 should be able to fund dividend payments of about $280 million to 300 million in 2020.

The company also has additional financial resources to support its dividend payments and other investments. At the end of the Q1, Quest had $342 million in cash and marketable securities. It can also borrow about $1.3 billion under its existing credit facilities. In 2020, the company has retired some outstanding notes with the funds that it obtained from recently issued notes. For example, in May, Quest used the proceeds from a public offering of $550 million 2.80% senior notes due 2031 to repay outstanding 4.70% senior notes due 2022. Thus, the company has able to reduce its interest expense while extending the average maturity of its senior notes.

Valuation

The brighter outlook, however, has not gone unnoticed by the market. After reaching a low of slightly over $73.00 on April 3, the stock hit an all-time high on June 3 of 123.87. At the current price of $114.31, the stock is now up about 60% from the April low.

Based on a forward P/E multiple of 15 to 16 times projected 2021 adjusted earnings per share, the market expects the company to earn $7.30 to $7.80 a share in 2021, 11% to 19% growth over the $6.56 a share that it reported in 2019. The market anticipates a more significant and sustainable recovery in its core business in 2020 and a much larger expansion in its COVID-19 testing business that can be deduced from the company's public filings and comments to the investment community.

Is it a buy?

It is difficult to adapt such an optimistic view when Quest can still not reasonably quantify the negative impact from the COVID-19 pandemic on its operations. Despite its recent announcement regarding Q2, the company has not provided any guidance regarding its financial and operational performance for the second half of 2020, let alone for 2021.

As a result, investors should remain cautious about purchasing additional shares of the stock unless the company provides more detailed information that supports a very strong and rapid recovery in the second half. Alternatively, the shares could also become more attractive if the shares correct and imply a lower rate of earnings growth.