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QUEST DIAGNOSTICS INC.
Shareowner, May/Jun 2004
It's All About Prevention
Quest's revenues and earnings have been growing at a high rate, consistently, for a long time. With such stocks, there is always the risk of a sharp decline in the multiple - and share price - resulting from a surprising decline in EPS growth or in the general stock market.
To recognize and minimize such risk, prudent investors who might consider purchasing the stock should also consider the merits of using a series of modest purchases spread out over several months, quarters and even years - rather than a single large purchase.
Currently, some 6,000 subscribers use ShareOwner's Low Cost Investing Program to make such risk-reducing purchases. Commissions start at under $2 per trade. - Editor
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Ouest Diagnostics (Quest) is the largest clinical laboratory testing business in the U.S. where the market for diagnostic testing is estimated at $37 billion annually; Quest has an estimated 12% of that market. In the U.S., spending on diagnostic testing represents about 2.5% of all health care expenditures and test results are involved in an estimated 70% of all patient-treatment decisions.
The company's testing services are used by the medical profession to diagnose, monitor and treat diseases and other conditions. Each year, the company's labs process specimens from some 130 million 'patient encounters' in almost every major metropolitan area in America.
Historical & Future Growth Prospects
Over the longer term, a stock's price only goes up "a lot" if the company's revenues and earnings go up "a lot". So let's start our study of potential appreciation in Quest's share price by understanding the reasons for its historical revenue growth and examining its prospects for growth during the next five years.
Revenues
The Stock Study Guide (opposite page) indicates that Quest's revenues have grown at an average 17% since 1995. Even higher average growth (25%) occurred during the last five years as a result of three significant acquisitions -the clinical laboratory services business of SmithKline Beecham in 1999, American Medical Laboratories in 2002. and Unilab Corporation in early 2003. For the fiscal year ending at December 31, 2003 revenue grew at 15% to $4.7 billion.
Important Products
Quest operates in three main segments: (1) routine testing; (2) esoteric testing; and, (3) clinical trials.
Routine Testing (80% of revenues in 2003 vs. 84% in 1998). Quest performs routine clinical and anatomical pathology tests principally at its 33 regional labs. Other facilities include 155 rapid response labs; 1900 patient service centers; and, hospital laboratories that Quest manages. Commonly ordered tests include those for: blood cholesterol and other blood disorders, pap smears, HIV, urinalysis, pregnancy and prenatal tests and substance abuse.
In 2003, the routine testing market had revenues of about $26 billion. Quest has an estimated 15% of this market.
Esoteric Testing (16% in 2003 vs. 13% in 1998). Esoteric tests are more complicated than routine tests and generate higher profit margins. However, esoteric tests generally require: sophisticated equipment; expensive technology and materials; significant attention to detail; and, highly skilled personnel.
Because these tests are prescribed relatively infrequently, many hospital labs find it too expensive to perform them inhousc. Such labs typically send this testing to reference labs like Quest.
Quest's esoteric testing (including gene-based testing) is conducted at facilities on both coasts - one in California and the other in Virginia - for cardiovascular disease, cancer and various infectious diseases. Quest has the largest gene-based testing business in the U.S. with revenues of over $500 million in 2003 (12% of its total revenue).
Clinical Trials Testing (3% in 2003 vs. 1% in 1998). Quest is the world's sec ond largest provider of clinical research trials for new drugs. These trials are typically performed to ensure that medications meet government standards for safety and efficacy before they are released to the public.
Other Services and Products (2% in 2003 vs. 2% in 1998). These revenues arise principally from sales of diagnostic test kits and clinical connectivity software for medical professionals.
Important Markets
Quest derives 98% of its revenues from the U.S. market. The remainder comes from clinical trials testing in England and through third parties in Australia, Singapore and South Africa.
Important Customers
Quest currently serves more than half of all U.S. hospitals and physicians through its network of testing facilities. No single customer accounts for more than 7% of Quest's revenues; two provide for more than 5%.
Important Competitors
The clinical laboratory testing industry is highly fragmented.
Quest's 12% share of the $37 billion diagnostic testing industry compares to its competitors as follows:
* hospital-based labs (60% share);
* independent labs (20%>); and,
* physician-affiliated labs (8%).
Quest's largest competitor is Laboratory Corporation of America (2003 revenue, $2.9 billion).
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