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Stay Away From This Laboratory

Stocks in this article: LH BRLI DGX SPY

NEW YORK (TheStreet) -- The medical laboratory tests and services company Laboratory Corporation of America (LH - Get Report), more commonly known as LabCorp, serves more than 220,000 clients, including physicians' offices, hospitals, managed care organizations and pharmaceutical companies.

LabCorp has been struggling with growth amid a challenging business environment. Its increasing costs have outpaced revenue growth, dragging profit margins. In 2014, LabCorp is expecting just 2% top line growth and an earnings drop. The business's financial strength is far from stellar, with a lofty debt-to-equity ratio and declining cash reserves. The company's shares underperformed this year and there are no catalysts at work that could change this in 2014. Following the recent sell-off, I believe that the company's shares are a sell on some recovery to low-to-mid-$90s in the coming weeks.

A week ago, LabCorp issued its 2014 guidance that came well below Wall Street's expectations. In 2014, LabCorp is eying revenue growth of just 2% and earnings of $6.50 per share, significantly below market's expectations of $7.54 per share. For the current year, LabCorp could record earnings of around $6.98 per share, which is the mid-point of its updated guidance. In other words, the company is expecting a 7% drop in earnings in 2014.

Following this disappointing guidance, the company's shares dropped by 11% the next day, its biggest one-day decline in more than six years. Investors were clearly taken by surprise. LabCorp, which is a low cost lab provider, was expected to be one of the few operators in this industry that could endure the tough market conditions.

The current challenging business environment will continue through 2014. LabCorp and its competitors, Bio-Reference Laboratories (BRLI) and Quest Laboratories (DGX), have been under pressure the last few years due to weakness in the domestic economy. Consumers have reduced their spending on medical services, while larger corporate customers have been implementing cost cutting measures. Both have had an adverse impact on these companies.

In the previous conference call, LabCorp's CEO David King said that he believed that the utilization environment has improved. Yet the business's recent press release has complained of the persistent "muted utilization environment."

Moreover, LabCorp's revenue and income will suffer as an increasing number of Americans face deductibles and co-insurance plans, and as the government throws up payment and reimbursement issues. In addition to these problems, there is the uncertainty about the implementation of the Affordable Care Act (popularly known as Obamacare). This has exacerbated the already tough market conditions.

In the long run, the implementation of the Affordable Care Act will increase the number of patients with coverage, which will translate into more business opportunities for LabCorp. In the short run, the situation will remain difficult through 2014. This is because Obamacare's implementation will be followed by a learning process for both consumers and laboratories as they adapt to this new law.

In other words, the implementation of the Affordable Care Act is not going to have any significant impact on LabCorp in 2014. Moreover, the sluggish growth of the domestic economy will continue through 2014.

Under this unfavorable business environment, LabCorp struggled with top and bottom line growth. In the first nine months of 2013, its revenue increased by just 2.5% from last year to $4.37 billion, while its operating income dropped by 4% to $775.9 million.

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