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Morningstar | DGX Updated Forecasts and Estimates from 08 Mar 2019

Quest Diagnostics posted fourth-quarter and full-year results that generally met our muted expectations, and our projections for 2019 fall within the range of management’s outlook; we’re leaving our fair value estimate unchanged for now. With the first year of Medicare clinical lab fee schedule cuts behind us, it’s become clear that the magnitude of reimbursement reductions driven by the Protecting Access to Medicare Act has turned out to be significantly larger than the industry or the Centers for Medicare and Medicaid Services, or CMS, had anticipated. Now CMS is taking steps to moderate the effect by including a large proportion of hospital-based labs in its next data collection and reporting period, which began on Jan. 1. Within the diagnostic lab industry, we continue to think the largest labs—Quest, LabCorp, Sonic, which all enjoy narrow economic moats—are better positioned to weather this period of intense reimbursement pressure. Nonetheless, as we see the considerable impact of PAMA on the lowest-cost producers, it’s not difficult to imagine the impact must be significantly greater on the higher-cost labs.

While fourth-quarter volume was solid, up 1.1% organically, we were struck by the 5.5% decline in revenue per requisition—the largest decline we’ve seen in the last decade. Quest’s rev-per-req was significantly worse than rival LabCorp’s in the fourth quarter. This decline is partially related to timing of collecting accounts receivable. Although Quest management did not indicate PAMA cuts to be a major factor in the decline (pointing to mix shift, payer denials, and patient price concessions), we are skeptical that PAMA cuts weren’t a driver. Overall, LabCorp did a better job of managing its quarterly rev-per-req decline of 40 basis points, with PAMA reducing the number by 100 basis points, only to be partially offset by more favorable test mix. We plan to keep our eye on this dynamic at Quest and adjust our expectations accordingly as 2019 unfolds.