DGX | Flu-Like Symptoms Result in COVID TestS
Background
Following the release of their bi-monthly “Media Statement about COVID-19” earlier this week, we updated the relevant data (CDC, IHME, BLS) and our model for Best Idea Long, Quest Diagnostics (DGX). Quest reported an average of ~78.5k molecular tests per day, outperforming our expectations and remained flat with the previous 14-day report. Based on what we can see from the CDC data, we know that molecular tests per day in the United States declined from 1.7MM to 1.5MM from September to October. During that same time, DGX returned to its negative trend in market share declining from 6.2% of all US COVID testing in September to 5.8% in October. In our forecast, we still expect DGX share to remain in the 6% range going forward.
DGX share price is most highly correlated to forward consensus estimate trends over the past 3 years, but during the pandemic, shares have been most highly correlated to the 7-day moving average of COVID cases in the US (94.7% since June 2021). As a result, Quest rallied with the Delta Variant and subsequently rolled over despite beating and raising guidance. In the short-term, we expect COVID cases to rise and DGX shares to rally, at least until the emerging COVID case wave peaks in late January. Beyond that point, the base business will be the key driver. If medical utilization rises dramatically, we could see sustained growth. If consensus is right, revenues go into a steep decline as COVID testing evaporates. If that is the case, shares are well overvalued based on its historical range across Sales, EBITDA, and EPS.
If COVID testing goes as we expect, we believe there is upside of 10%-20% in the immediate term. Although flu isn’t accelerating yet, we're looking for a pick up in flu testing that will most likely be done in conjunction with a COVID test. We also expect the base business to accelerate as this next COVID peak is unlikely to come with the same hospitalization rates we've seen in prior waves. The base business trends will decide if DGX is a long or a short post January, but the upside scenario in the short-term and the catalysts look clear to us.
Thesis
When management set their guidance for molecular tests at an average of 50k tests per day for 4Q21, we suspected the number was low and began building a table to track with relatively high certainty the molecular volume for Quest per day in the quarter. With it in mind that DGX represents 6% of the share, that would mean the US average for COVID tests would be ~861k tests per day and would’ve needed to exit the quarter at 229.5k tests, an 86% decline from the 1.6M tests per day at the end of last quarter. Quest is currently completing approximately 80k tests per day, meaning they would need to exit at approximately 5K tests per day to achieve an average of 50k for the quarter. We believe that is highly unlikely.
The forecast from IHME now extends through March 2022 and anticipates COVID cases will continue accelerating through 1Q22. We believe the potential for flu is likely to move higher as more people congregate indoors and social distancing eases as we re-open. Our model forecasts COVID testing volume of ~65.5k per day for 4Q21 with potential for further upside due to a prolonged spike and downside if surveillance testing becomes a larger part of the mix.
Elevated COVID testing will drive revenue estimates higher in 2022. Additionally, the incrementally higher margin revenue will drop straight to EBITDA and EPS. DGX continues to receive nearly $90 reimbursement on a COVID test which we believe costs them between $35 and $40 to produce. Keep in mind that transportation and labor are pieces of the cost; actual materials are probably closer to $10 per test. Meanwhile, a base business test costs $28.50 to produce and is reimbursed at $44, resulting in a ~35% gross margin.
Valuation
Based on our estimates, we have modeled 2021 revenue to $10.59B versus consensus of $10.53B, just slightly inside of the high point of management’s full year guidance of $10.60B. As a result of the flu season impact, we have modeled 2022 revenue to $9.35B versus consensus of $8.75B, particularly driven by a 12% gap between our numbers and consensus in 1H22. As for EPS, we expect $13.88 in 2021 and $8.95 in 2022 versus consensus of $13.70 and $8.16, respectively. While the current thesis is heavily fixated on the potential for COVID testing to incite a positive estimate revision over the coming quarters, we believe there could be further upside created by pent-up demand manifested as higher acuity. From 2023 estimates, we know that consensus is modeling a sizable drop in revenue, but we continue to see evidence of material pent-up demand which could lead to additional volume upside into 2023.
We believe DGX shares could trade at a 2022 EV/Sales multiple between 2.7x-2.8x, representing 10%-20% upside in the near-term. DGX is a long into 1Q22, and perhaps longer depending on the pace of the base business.
Catalysts
- Media Coverage on Rising Cases During the Flu Season | While a lack of hospitalizations and deaths will make the media frenzy surrounding COVID-19 less emphatic this time around, the reverse in average cases per day will be plastered across the media while it is increasing. Any acceleration won’t go unnoticed.
- Recovery in NYC based on Path Train Traffic | Aside from New York City, Quest’s volume has reached the 2019 baseline that they have used for reference during the pandemic. Utilizing data from the NY-NJ Path Train, we have a way to map and monitor the city’s recovery and its impact to volume.
- Evidence of Pent-Up Demand | Across our many datasets, we have encountered a mounting number of series to support the material evidence of pent-up demand. While we are not sure how it will manifest, although we believe it could be through lower-than-normal no show rates, we know there is a significant amount of volume still on the sidelines.
Risks
- COVID Cases Don't Spike Again | While we feel overwhelmingly confident in the data we have seen, as well as the model we have successfully relied on from the IHME and the University of Washington to this point, the thesis here is heavily fixated on the idea that COVID cases have one last wave that peaks in January 2022.
- Rising COVID Causes Further Delays | The vaccination rates, which are high, but not high enough to reach herd immunity, in conjunction with Pfizer’s pill should be enough to reduce hospitalizations in death from COVID-19. With that in mind, the hype could cause further delays in the return to in-person care.
- Lab Worker Wages & Employment | Utilizing data from the BLS, we know that lab worker wages have been muted to this point relative to industry trends. DGX has gone above and beyond to reward their employees who managed through the pandemic, but we will keep our eye on the time series.
- Rising Pump Prices | We also maintain a dataset for US pump prices as the incremental cost can create gross margin pressure due to the number of times spent driving to collect and transport samples.
Key Slides
Our model is up-to-date and available for interested Health Care Subscribers, as well as all data available upon request. Please reach out to with any inquiries.
Thomas Tobin
Managing Director
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