DGX | Following a Roll-Over in Cases, Multiple Likely to Regress
Background
Amidst a number of data points provided by the JPM Healthcare Conference, Quest Diagnostics (DGX) pre-announced FY21 Revenue and EPS, as well as uncharacteristically released a “Media Statement about COVID-19” prior to their presentation yesterday. As expected, the company reported preliminary results above not only guidance and consensus, but also slightly stronger than our own expectations with roughly $2.74B reported versus our estimate of $2.69B and consensus of $2.51B. Adjusted EPS is expected to be $3.33/share versus our estimate of $3.21/share. Outperformance this quarter was driven by stronger-than-expected COVID testing related to the Omicron variant and continued recovery in the base business despite the impact of the variant.
Additionally, the media statement demonstrates a continued improvement in average molecular tests per day now running at an average of 157.1k tests per day in the most recent week, up sequentially from the 121.4k average tests per day reported in the prior 2-week period. Based on our model, we expect cases to roll over in the coming weeks followed by a steep deceleration. From DGX’s own comments yesterday and reinforced by our contacts in the field, we believe this could be the end of hyper-disruptive, national COVID spikes. While we may experience regional breakouts due to low vaccination rates or tourism, the tailwinds from high priced and high margin COVID is turning into a major headwind.
Thesis
In our Stock Brief last week, we laid out our initial thoughts for a flip from Best Idea Long to Best Idea Short for DGX. We waited to push it over the line to give Quest a chance to present and further define their opportunity going forward at the conference. Despite what we would describe as an excellent showing, the catalyst path following a rollover in cases appears overwhelmingly negative as COVID cases rapidly decline from the current rate of ~175k average tests per day. We do not expect that a 4%-5% recovery in the base business will be enough to fill the gap and support topline growth as well as the current multiple.
Now sitting at nearly 2.6x EV/2022 Sales, we believe the stock should regress to the lower end of its historical multiple range of 2.0x-2.2x. Based on what we can see from our own data paired with this week’s comments at JPM, we suspect a significant delay in the broader medical economy recovery and pent-up demand release later than 1Q22 in part due to the lingering impacts of Omicron as well as labor shortages likely to persist for several more quarters.
From the MicroQuad perspective, DGX’s revenue estimate trend is in MicroQuad 4, an especially vulnerable position without a source of significant upside. The lack of upside in the short term and a series of potential headwinds after Omicron peaks in the next few weeks has led us to push DGX to an Active Short.
Valuation
Following the catalyst yesterday, we have updated our data and made adjustments to additional assumptions in our model. Based on our estimates, we have modeled 2022 revenue to $9.11B versus consensus of $9.01B, 2022 adjusted EBITDA of $1.93B versus consensus of $1.92B, and 2022 EPS of $8.75 versus consensus of $8.79, driven by the aforementioned headwinds anticipated throughout the year. We believe DGX shares could trade at a 2022 EV/EBITDA multiple between 9.0x- 11.0x, representing 10%- 30% downside in the near-term. Following the release of the 10-K for FY21, we will solidify our estimates for FY23.
Catalysts/Risks
- 4Q21 Earnings Call in February & FY22 Guidance | Following the pre-announcement yesterday, the next major catalyst will be the company’s FY21 earnings release and initial guidance for FY22. On that call, we will be listening for commentary on further recovery of the base business including any Omicron-related delays, demand for pooled surveillance testing, changes to CMS reimbursement, and trends in premium pricing for logistics and supplies.
- Further Variants Delay Surveillance Testing Demand | At JPM, there was no mention of pooled testing. Lately, we have heard a number of negative reviews as to the efficacy and rationality behind the often-discussed “return-to-life” procedure. If molecular PCR tests were to remain in favor throughout 2022, the mix would remain heavily skewed to the higher margin tests.
- Evidence of Pent-Up Demand (NY-NJ Path Train Traffic) | Across our many datasets, we have encountered a mounting number of series to support the material evidence of pent-up demand. While we believe the release has been delayed by Omicron, the resumption of pre-COVID activity levels despite outbreaks is a key factor to monitor. 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.
- Lab Worker Wages & Employment and Rising Pump Prices | The theme of this year’s conference could have been Labor Shortage given the multitude of questions. For DGX, premium pricing on labor, supplies, and gas prices are all potential headwinds in 2022. Utilizing data from the BLS and a dataset for US pump prices, we will have a good indication of the trends in these gross margin pressures.
Key Slides
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Thomas Tobin
Managing Director
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