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DGX | Best Idea Long | COVID Testing Sustained Alongside Re-Opening (+/+) Please join us on Friday, August 6, 2021 @ 10 AM ET Participating Dialing Instructions Toll Free: Toll: UK: 0 Confirmation Number: 13722247 Healthcare Subscribers CLICK HERE for event details (includes video and materials link) |
HEDGEYE HEALTH CARE WRITE-UP
Background
Quest Diagnostics (DGX) is one of two central labs in the United States which hold sizeable contracts with many large hospital systems, networks of doctors, and insurance providers. As a result, Quest acts as a significant cog within the US Medical Economy, representing one fourth of all clinical testing. During the onset of the COVID-19 pandemic, DGX was tasked with deferring significant base business volume in exchange for undertaking roughly 20% of all COVID testing. The substantial demand for high priced and high margin molecular molecular COVID-19 testing encouraged capacity in the form of new capacity, labs and point of care solutions seeking to take a portion of the market, and DGX market share has fallen to ~6%.
In the base business, DGX has experienced material recovery since the lockdowns of 2Q20 while also maintaining COVID tasting capacity of more than 5x their current volume. Now that base business volumes have recovered to the company’s pre-COVID 2019 baseline, we believe that Quest is better positioned than it was before the pandemic to execute their growth strategy going forward including acquisitions and buybacks.
Thesis
In early January, we expected COVID vaccinations would drive a rebound of in-person care and COVID-19 testing would fade and along with infections. However, with vaccination rates remaining low enough to sustain the another outbreak, but so far not high enough to push the country back into lock down and hider the return to in-person care, the end of COVID testing is significantly delayed (potentially six months to a year).
The key to our thesis is DGX's guidance for the near elimination of COVID volume in the coming months in the midst of yet another wave of infections. But instead of lock downs we expect the continued emergence of in-person care. We also expect the continued migration back to less socially distanced environments such as offices, which will exacerbate COVID-19 spread along with influenza off the near-zero levels of 2020-2021 season. Should COVID testing remain at an elevated and the recovery in the base business remains in tact, we believe company estimates could be revised significantly higher. It also seems more likely that COVID-19 will require monitoring for years to come, delaying a COVID-19 comp already in estimates.
Valuation
Although the correlation to price is relatively similar between EV to Sales and EPS, we chose to value DGX using its EV/Sales multiple which historically trades between 2.0x and 2.6x. EV/Sales also affords us the opportunity to separate COVID revenue to create a blended multiple. While the multiple remains stable historically, we believe that the potential for prolonged COVID testing, faster-than-expected recovery in the base business, and meaningful contributions from the PLS business in 2022 will enact a series of positive estimate revisions and further multiple expansion (to the top of the range). Based on the business’ potential ceiling and utilizing the midpoint of its historical trading range, we have modeled 2021 revenue to $9.823B versus consensus of $9.679B and 2022 revenue of $8.665 versus consensus of $8.578B, yielding 10%-50% upside from the current price.
Catalysts
- COVID Testing Tracker (based on CDC Data) | We receive daily US COVID testing data which can be analyzed and used to forecast DGX’s average COVID tests per day with a high degree of accuracy. Given that the low point of guidance assumes an average of 20k COVID test per day, this dataset will give us a good indication of the current pace.
- Hedgeye Proprietary Data Updates (Forecast Algorithm, App Downloads) | Alongside our daily COVID Testing Tracker, we have developed a number of proprietary and publicly available data sources which, in combination, will provide an accurate representation of Quest’s landscape. These tools include a forecast algorithm for Quest’s organic requisition volume, app downloads and daily active users for the MyQuest app, and a number of medical lab time series which the BLS updates monthly.
- DGX Bi-Monthly Media Statements on COVID-19 | During the pandemic, Quest’s management team began releasing their current COVID-19 volume for both molecular and serology testing, as well as the capacity for these tests. These updates will not only provide support/opposition for our thesis around current COVID testing levels but will also provide a bogey for us to test our COVID Tracker.
- Conference Appearances & M&A Announcements | DGX is set to speak next at the Morgan Stanley Global Health Care Conference on September 9, 2021, where investors will have an opportunity to ask questions on a number of the thesis points we laid out above. These opportunities, as well as additional announcements of continued M&A afford management the opportunity to prove further commitment to their story.
Risks
- Point-of-Care versus Central Labs | Additional COVID demand for testing gave way for a number of smaller or previously defunct labs to re-tool and provide a meaningful contribution to the fight against COVID-19. Although these labs look to be disadvantaged in terms of proximity and price nationally, their ability to capitalize on COVID to win contracts in locales where they have a regional advantage would infringe on Quest’s potential throughput.
- Labor Inflation Throughout Healthcare | As we’ve seen positively in our long thesis for AMN, wages have risen and remain elevated throughout the US Medical Economy as a result of the pandemic. Given what we can see from the BLS data and our work on the type of laborers necessary to meet incremental volume, we do not expect DGX to experience a significant impact from labor inflation.
- Additional Costs due to Supply Chain | Earlier in the year, we dedicated significant time quantifying the potential for supply chain disruptions as the result of international COVID outbreaks. Based on management’s commentary and our own field work, we do not foresee this to have a material impact on Quest’s COGS.
All data available upon request. Please reach out to with any inquiries.
Thomas Tobin
Managing Director
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