Clinical Lab Industry
INITIATION
Initiation of Independent Clinical Lab Sector
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Initiating coverage of the independent clinical lab sector with a Market
Weight. We have a generally favorable view of the lab market; however,
concerns around industry pricing cause us to take a more conservative
stance on the group at this time.
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Several positive factors are driving industry growth. We expect growth
in complex or esoteric testing, and the introduction of new tests to be the
primary drivers of growth in the $48 billion lab market. In addition, macro
drivers such as increased awareness and recognition of the cost/benefit of
preventative care measures, and a favorable shift in demographics should
help fuel underlying growth.
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Expect Quest and LabCorp to grow in excess of market growth rates.
The lab sector is dominated by two providers, Quest Diagnostics and
LabCorp, which together command a roughly 64% share of the independent
clinical lab market. We expect these two providers to grow in excess of the
estimated 5-6% annual industry growth via market share gains from
hospitals, further consolidation, and a favorable mix shift.
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No “price war” expected, but we see risk of further price erosion. Our
concern around pricing stems from recent exclusive agreements in the
industry. These agreements command price discounts for greater volume
through exclusivity. Although we are not expecting a “price war” in the lab
industry, we believe there may be unintended consequences of the recent
exclusive deals that could lead to further price erosion.
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Pricing issue leads to greater volatility and divergence in correlation.
Despite the pricing concerns, average sector performance continues to
outperform the market. However, the issue around pricing has led to greater
volatility for shares of Quest and LabCorp, and a break in the historical
correlation between the two.
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DGX and LH are solid companies; greater upside in LabCorp in the
near term. We view both Quest and LabCorp as well-managed companies
with good earnings potential, solid capital structure, and attractive free cash
flow characteristics, operating in a relatively stable industry. However, we
believe the UNH/LH exclusive agreement provides greater opportunities and
potential upside for LabCorp, at least over the next 12-18 months.
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We are initiating coverage of LabCorp (LH) with an Outperform rating
and $89 price target, and initiating coverage of Quest Diagnostics
(DGX) with a Neutral rating and $61 price target.