CRA Celera Corp. (MM)

The announcement of Quest Diagnostics’ (DGX) first quarter of fiscal 2011 results as on April 20, 2011, has triggered analysts to revise estimates downwards.

Previous quarter highlights

Quest Diagnostics reported an adjusted EPS of $1.00 during the first quarter of fiscal 2011, a penny above the Zacks Consensus Estimate and the year-ago quarter. Revenues for the quarter increased 1% year over year to $1.8 billion, in line with the Zacks Consensus Estimate. A 10.5% decline in the number of outstanding shares had a favorable impact on earnings.

The adjusted earnings in the reported quarter excludes the impact of severe weather (7 cents), costs associated with workforce reduction (5 cents) and recent transactions (2 cents) related to Athena Diagnostics and Celera Corporation (CRA). The year-ago period also witnessed the impact of severe weather (5 cents) and restructuring charges (6 cents).

Clinical testing revenues, which account for most of Quest’s sales, increased 0.3% compared to the prior year. While clinical testing volume (measured by the number of requisitions) during the quarter increased by 2% compared with the year-ago period, revenue per requisition was lower by 1.7%. The impact of a severe weather during the quarter reduced revenues and volume by 1.4%

Quest updated its outlook for 2011. The company expects to report an adjusted EPS of $4.25-$4.45 banking on a 2% growth in revenues (1% growth as per previous guidance). This reflects a 1% increase based on the Athena acquisition. The company expects operating margin to be around 17.5%−18% (adjusted) and to generate $1.1 billion in cash from operations.

For a full coverage on the earnings, read: Quest Diagnostics Beats by a Penny

Agreement of Analysts

Following the release of first quarter results, estimate revision trends among analysts depict a negative bias for the company’s earnings in the forthcoming periods. Over the last 7 days, 4 of the 21 analysts covering the stock have lowered their revisions for the second quarter of fiscal 2011, with no revision in the opposite direction.

Moreover, in the past 30 days, 15 analysts have lowered their estimates for the second quarter with only one moving in the reverse direction. However, the situation improves a bit in the second half of 2011.

For the third quarter, 5 analysts lowered their estimates with 4 in the opposite direction in the last 30 days. For fiscal 2011, out of 19 analysts, 14 have reduced their estimates in the last 30 days with no upward revisions.

After several quarters of declining clinical testing volume, Quest recorded a positive 0.1% volume growth during the fourth quarter of 2010. It is encouraging to note that volume growth improved further to 2% during the first quarter of 2011. Moreover, physician office visits (Quest derives 80% of its business from physician office visits), though down, is showing some improvement and is not expected to change significantly from the current level thereby resulting in some stability going forward.

Revenue per requisition continues to be under pressure ever since the contracts were renewed during the second quarter of 2010. However, with the completion of one year of this event, the company expects stability in revenue per requisition in the second half of 2011. The situation of the company reflects the estimate revision trends by the analysts that improve as the year progresses.

Adjusted operating margin in the reported quarter declined to 16.3% compared to 18.1% in the year-ago period. Higher operating costs and expenses related to salaries and wages resulted in lower operating margin. However, the company is striving to better manage its cost structure, evaluate a number of new opportunities and bring about quality improvements.

To meet these objectives, Quest has made investments in the recent past in sales and service, which are temporarily pressurizing margins. However, over a longer time period, these investments should result in accelerated revenue growth and margin expansion.

To benefit in the long term, Quest is focusing on areas with high potential such as gene-based, esoteric and anatomic pathology testing, which accounted for approximately 36% of the company’s total revenue in 2010.

Quest continues to face challenges as its anatomic pathology still sees a drop in revenues. This is significant as this high-margin business contributes about 14% of the company’s total sales. Moreover, low-margin drugs-of-abuse testing recorded an 11% growth during the quarter, though the contribution to the volume was modest (0.5%).

Magnitude of Estimate Revisions

The magnitude of revisions is modest following the first quarter results. Overall, estimates for the next quarter have gone down by 4 cents to $1.14 while third-quarter estimate remained unchanged at $1.17. Estimates for fiscal 2011 also witnessed a decline of 8 cents to $4.36 over the last 30 days.

Our Recommendation

We appreciate Quest’s move of repurchasing shares and paying dividends to drive shareholder value. Besides, the company is adopting strategies such as suitable acquisitions, increased sales force and targeting additional geographies to drive its top line.

With positive volume growth during the quarter coupled with expected stability in pricing from the second half of 2011, the company is gearing for a gradual recovery. We are encouraged by Quest’s strong portfolio of tests, many of which are finding greater acceptance with time.

We have a ‘Neutral’ recommendation on the stock which corresponds to the Zacks # 3 Rank (Hold).

About Earnings Estimate Scorecard

Len Zacks, PhD in mathematics from MIT, proved over 30 years ago that earnings estimate revisions are the most powerful force impacting stock prices. He turned this ground breaking discovery into two of the most celebrating stock rating systems in use today. The Zacks Rank for stock trading in a 1 to 3 month time horizon and the Zacks Recommendation for long-term investing (6+ months). These “Earnings Estimate Scorecard" articles help analyze the important aspects of estimate revisions for each stock after their quarterly earnings announcements. Learn more about earnings estimates and our proven stock ratings at http://www.zacks.com/education/

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