Stay Away From This Laboratory

NEW YORK (TheStreet) -- The medical laboratory tests and services company Laboratory Corporation of America (LH), 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.

Although LabCorp has been able to hold its selling, general and administrative expenses fairly flat, the company has reported a 4.7% increase in costs. This increase is nearly twice as big as the increase in revenues; therefore, the company's gross profit margin has dropped by nearly 130 basis points to 38.8%.

Historically, acquisitions have been a large part of the company's growth strategy. The business has been spending half of its free cash flow on acquisitions and half on share repurchase. So far in 2013, LabCorp has spent nearly $100 million on acquisitions.

During the conference call, management pointed out that in the absence of a major acquisition in 2014, the company will use more leverage to repurchase shares. In that case, while it will return cash to shareholders, its top line growth, which is already under pressure, could take a hit.

Moreover, LabCorp's financial strength is far from ideal. Like most of the companies whose growth is driven by acquisitions, LabCorp operates under a massive pile of debt. The company's current long term debt, excluding the debt's current portion, now stands at $2.55 billion, showing an increase of 17.4% from the end of last year. Its long term debt-to-equity ratio now stands at nearly 100, which is more than twice as large as the industry's average of 48.

Moreover, in the corresponding period, LabCorp's cash reserves have plummeted by 63% from $467 million in December 2012 to just $174 million by the end of September.

In 2013, LabCorp's shares have been up 3.7%, largely due to the weak guidance mentioned earlier. Prior to the announcement of the guidance, from the beginning of the current year, the business's shares were up 14.5%. That looks better, but they have underperformed as compared to the SPDR S&P-500 ETF ( SPY), which has risen by 27% in the same period.

My advice: stay away from this laboratory.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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