Big, bad managed care company UnitedHealth Group (NYSE:UNH) recently pulled the carpet out from under Quest Diagnostics (NYSE:DGX), turning to a rival for its lab-testing needs. Fools should carefully consider the investment implications of this short-term setback, because Quest should eventually regain its footing.
The loss of the UnitedHealth contract to archrival LabCorp (NYSE:LH) was the primary reason Quest announced lower earnings in yesterday's first-quarter results. It also means that the coming year will see flat results compared with last year's numbers. That may not be good news if your investment horizon is only the next 12-18 months, but it could be just the right medicine for long-term-minded Fools.
Quest's recent track record is impressive, having grown sales 10% and cash flow just more than 18% annually over the past five years. Both Quest and LabCorp have capitalized on strong industry trends to generate internal growth, while simultaneously acquiring their way into the independent diagnostic sector's top two spots. Hospitals still control most of the lab-testing market, but they still use outside firms such as Quest and LabCorp. So do doctors' offices and other health-care providers.
That's good news, especially considering that the demographic trends of an aging America support growing health-care demand. More older patients should mean more related lab tests to measure blood levels and detect potential illnesses. Specialized medicine also supports the analysis of individual genes -- referred to in the industry as "esoteric testing" -- which also carries higher profit margins.
This means the lab-testing outlook is still compelling, and Quest and LabCorp could be the primary beneficiaries. So could smaller rivals Bio-Reference Labs (NASDAQ:BRLI) and MEDTOX (NASDAQ:MTOX).
Quest's coming year may turn out flat, but the company already announced a significant acquisition of privately held AmeriPath, which could help it post some top and bottom-line growth. In any case, the shares trade for a reasonable 17.5 times earnings, and an even lower multiple of free cash flow, based on information provided in the earnings release.
The Motley Fool CAPS community seems bullish on Quest, thanks to its four-star rating. LabCorp has the highest five-star rating, but more contrarian-minded Fools may want to further diagnose Quest's recent events.
For related Foolishness:
- Quest Diagnostics Becomes Un-United: Fool by Numbers
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- The Warren Buffett Mutual Fund
UnitedHealth and LabCorp are Motley Fool Stock Advisor recommendations. UnitedHealth is also a Motley Fool Inside Value selection. Whatever your investing style, the Motley Fool has a service for you.
Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.
