Quest Diagnostics Pursues Turnaround with Few Results in First Quarter

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Quest Diagnostics continues to implement its turnaround, but few tangible results were evident in its first quarter performance. While Quest enjoys a narrow moat thanks to its position in a duopoly that dominates the independent reference lab market, there is plenty the firm could do more efficiently, from many analyst’s perspective.

Since CEO Stephen Rusckowski joined the company, he has pinpointed a number of elements that could stand improvement, including shrinking the layers of management; standardizing systems, processes, and procurement; and increasing automation. If Rusckowski can put these new initiatives into place, Quest can solidify its narrow moat. Having said that, introducing change and fundamentally altering Quest’s culture will take time, and analysts are not surprised that the benefits of all this restructuring have yet to appear in the firm’s financial performance.

Quest continues to trail rival LabCorp LH even as health care utilization has begun to ease. Organic volume, adjusted for business days, fell approximately 2.4% during first quarter. Additionally, revenue per requisition also declined in the low single digits, thanks to cuts in reimbursement. This weakness hit Quest on both the top and bottom lines. Analysts expect the softness in revenue per requisition will linger in 2013 until we reach the anniversary of the major cuts in January.

Moreover, Quest is relatively more vulnerable to the recent Medicare reimbursement cut on the technical component of surgical pathology tests thanks to its dependence on anatomic pathology, which accounted for roughly 12% of total 2012 revenue. This reimbursement cut will hurt Quest in the near term. However, over the longer term, we anticipate the same cut will make it much less financially attractive for physicians to bring anatomic pathology testing in-house, which will ultimately benefit Quest when that test volume flows back to the independent labs.

In the meantime, Quest has intensified its pursuit of hospital outreach programs. It will take some time before the wisdom of this move can be demonstrated. With hospitals eager to enhance revenue generation, many of them are seeking to optimize their hospital-based lab assets. Rather than trying to directly beat hospitals at this game, Quest has opted for collaboration. It may take another three or four years before hospitals either recede from outreach, or turn into permanent competitors.

 

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