Quest Down; But Is Market Diagnosis Right? - TheStreet

Quest Down; But Is Market Diagnosis Right?

Quest Diagnostics is down on Monday after an in-line earnings report, presenting investors with a decision on whether to buy the health care stock on short-term weakness.
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MADISON, N.J. (

TheStreet

) -- Although

Quest Diagnostics

(DGX) - Get Report

reported earnings fourth quarter earnings basically in line with Street estimates, the health care diagnostics company has been down since the opening bell on Monday morning.

Quest is trading down -- by approximately 4% on Monday morning -- as much because its past earnings have been strong as because Monday's morning 's pre-market open fourth quarter earnings were slightly weaker than previous outperformance. Quest trading had already surpassed its average daily trading volume within an hour of the market open on Monday.

For long-term investors in Quest Diagnostics, the market's negative reaction to the "in line" earnings will probably be a short-term buying opportunity. Other investors, conceivably, may read Quest Diagnostic's conservative guidance toward 2010 as providing room for outperformance, too.

Quest Diagnostics expects earnings per share of between $4.10 and $4.30 in 2010, versus a Street consensus of $4.20. Quest also expects revenue growth of 3% to 4% in 2010. Analysts say that if the economy improves more than expected, Quest Diagnostics could beat these relatively conservative estimates. In 2009, Quest reported EBITDA of $1.4 billion on revenue of $7.5 billion.

However, the fourth quarter numbers from Quest were at least a little disappointing, according to analysts. Revenue was only up 2.7% in the fourth quarter, whereas in the previous two quarters, Quest Diagnostic revenues had been up 3.9% and 3.5%, respectively. What's more, Quest has beaten the Street in 14 of the last 18 quarters, and so, its in-line earnings per share in the fourth quarter was a disappointment in as much as it was in line with, as opposed to ahead, of the Street.

"Sometimes they have been beating by a healthy margin, not an in-line number, so the expectations were higher," said Anthony Vendetti, analyst at Maxim Group. Maxim put out a note this morning instructing investors that it expected Quest Diagnostics to be weak on the earnings and that this would represent a buying opportunity.

Quest reported earnings per share of 97 cents. However, it is important to note that bad debt expense in the quarter was reduced from 4.3% to 3.9%, and without that debt reduction, the earnings would have missed the Street. In previous quarters, Quest Diagnostics has beaten the Street on cost reductions and margin improvement.

Maxim Group's Vendetti said that Quest Diagnostic's drug-testing business continues to be a drag on earnings. What's more, a second analyst noted that even though drug testing continues to be a drag, it was less of a drag in the fourth quarter than previous quarters.

"It was not too exciting a quarter, with volume up half a percent, and the economy was really a bigger drag than the drug-testing business specifically," said the second analyst, who did not want to be quoted before having more time to study the report.

Clinical testing volume, ex-drug testing, was only up by half a percent in the fourth quarter, versus an increase of more than 1% in the previous quarter.

However, the second analyst agreed with Maxim's Vendetti on the long-term outlook for Quest Diagnostics. "If you are a long-term holder, it is a solid name to own on a pullback now; people who like Quest will be buying on weakness; the hedge funds out there who like Quest's cash flow generation will push the stock back up at least a little today from its early downward trend," the analyst argued.

"The expectation was that Quest would continue to outperform, even in a difficult economy, but this quarter the economy proved a little too daunting, " Maxim's Vendetti said.

Quest announced alongside the earnings -- and possibly to coincide with its expectation that the market reaction would be slightly negative -- a share repurchase program of $750 million. Analysts noted that while the share repurchase may have been timed to show confidence in the stock from Quest Diagnostics management at a time of slightly weaker earnings, it has been on the docket for 2010 for some time already, and is no surprise.

Quest's closest competitor,

LabCorp

(LH) - Get Report

, was also down early on Monday, though less than 1%. LabCorp will report on Feb. 11.

Analysts said while LabCorp was probably down on Monday due to the negative reaction to Quest Diagnostic's earnings, LabCorp is a different animal headed into 2010, with acquisitions still being digested -- and potentially accretive to earnings.

For both LabCorp and Quest, though, one thing in common is cash flow. "LabCorp is down today also because, like Quest, they have been beating the Street, but Quest's earnings don't change the basic thesis: these companies are both producing prodigious amounts of cash flow from operations," Maxim's Vendetti said.

Quest Diagnostic's reported operating income for 2009 was $1.4 billion, versus $1.2 billion in 2008.

-- Reported by Eric Rosenbaum in New York.

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