LabCorp's Challenges Ahead
LabCorp's Challenges Ahead
The U.S. clinical testing industry is
an important component of the healthcare system. It is the part of the
system which helps confirm or make diagnosis, monitor disease states and
provide treatment rationale data. It generally consists of two
segments: hospital-based labs which makes up approximately 40% of
testing volume and outpatient which comprises 60%. The outpatient
segment has three main components: physician office laboratories,
hospital outreach and independent clinical labs.
The total clinical lab testing
industry in the U.S. generated approximately $60 billion in revenues in
2014, and of that commercial clinical laboratories accounted for
approximately one-third of testing volume according to industry leaders
Quest Diagnostics Inc.'s (DGX) and Laboratory Corp of America Holdings' (LH) most recent annual reports. Quest Diagnostics and LabCorp, the number one and two independent labs respectively, compete with the other hospital and non-hospital-based labs.
Business Model
LabCorp, based in Burlington, North Carolina, has two main lines of
business that consist of clinical laboratory testing and contract
research organization business. This $12.25 billion market capitalization
company’s clinical laboratory testing business assists in detection,
diagnosis, evaluation, monitoring and treatment of diseases and other
medical conditions. The clinical laboratory business is intensely
competitive. Despite being the second largest independent lab, many
smaller labs compete with the larger players for patient volumes.
Like the clinical laboratory industry, the contract research
organization industry has many competitors ranging from hundreds of
small, limited‑service providers to a limited number of full‑service
contract research organizations with global capabilities, according to
LabCorp's 2014 annual report. The contract research organization
(CRO) industry provides research services to the pharmaceutical or
biotech industries to assist during clinical trials and other research.
LabCorp's CRO business was recently enhanced by the 2014 acquisition
of Covance, and is now named Covance Drug Development. LabCorp states
this “business primarily competes against in‑house departments of
pharmaceutical companies, full-service and limited‑service contract
research organizations and, to a lesser extent, selected universities
and teaching hospitals.” (For related reading, see: The "Healthy" Play in Contract Research Organizations.)
Factors Affecting Profitability: Regulations and Seasonality
The Affordable Care Act of 2010
has increased the number of insured individuals in the U.S., creating
an opportunity to serve more Americans and increase testing volume. At
the same time, the primary insurers—Medicare (which principally serves patients 65 and older), Medicaid
(which principally services low-income patients) and third party
insurers—have put forth renewed “efforts to control the cost,
utilization and delivery of health care services,” according to the
LabCorp annual report. This has resulted in lower pricing and limited
ability to set prices, at the same time pressuring individuals to
decrease usage as their co-pays have also increased. (For more, see: Essential Health Benefits Under the Affordable Care Act.)
Lab testing tends to experience periods of time throughout the year when volumes decline, this trend is more broadly called seasonality.
These declines usually happen during holiday periods and during the
summer months when vacations are more prevalent. Utilization also
declines during severe weather.
Investment Thesis and Valuation
The profitability of LabCorp is impacted by a few factors. Volume or
the number of tests performed is a major contributor to profitability.
But total volume alone does not explain changes in profitability. The
level of volume for the different types of tests and the payer mix are
highly correlated with a change in profitability.
There are many different varieties of clinical tests and LabCorp
lumps them into two buckets called core testing and genomic and esoteric
testing. Volume at LabCorp's
Clinical Diagnostics Lab shows that core testing has almost three times
more volume compared to genomic and esoteric testing, but genomic and
esoteric testing provided more than one-and-a-half times more revenue
per requisition (test) than core testing in 2014.
In terms of payer mix, in 2014, Medicare and Medicaid (government
sponsored insurance) make up only 14% of LabCorp's patients but they are
the most profitable. Commercial and managed care patients comprise 84%
of the patients, but provide on average 15.6% less revenue per patient
compared to Medicare/Medicaid.
Because the payer mix and volume type play a major role in
determining profitability, any change in regulations or reimbursement
cuts directly impact LabCorp's earnings. The risk of lower reimbursement
tends to coincide with weak volumes, slowing clinical laboratory growth
rates. Slower growth usually puts downward pressure on valuation
metrics. Currently, LabCorp is trading at a forward price-to-earnings (P/E) ratio of 12.9 times and an enterprise value-to-earnings before interest taxes, depreciation and amortization
(EV/EBITDA) ratio of 7.1 times. The forward P/E is slightly higher than
its nearest competitor, Quest Diagnostics, but the EV/EBITDA is
slightly lower than Quest Diagnostic’s 7.3 times, putting LabCorp around
a similar valuation as Quest Diagnostics.
The Bottom Line
LabCorp is in a business that gets pressured at times based on
regulatory changes and reimbursement cuts. But in the long run, this is a
business that aids the healthcare industry in making good medical
decisions. LabCorp is one of two national players that experiences
strong competition from local labs and has a limited ability to set
prices, except where new and innovative tests are developed and
administered.
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