LabCorp: Adjusting Our Fair Value Estimate for the Spinoff of Fortrea

We’ve lowered our fair value estimate on narrow-moat-rated LabCorp LH to $233 per share, down from $271, after adjusting for the spinoff of the drug development business.

In terms of the moat, the spinoff of the drug development business is immaterial to LabCorp’s narrow economic moat in its diagnostics lab business, in our view. LabCorp’s diagnostics moat is firmly grounded in its cost advantage. The firm’s prowess with information technology and sheer volume of tests means it can run significantly more tests through its fixed network for labs for significantly less cost, compared with smaller independent labs and hospital-based labs. We see little that would materially change LabCorp’s position as a low-cost producer.

Valuation-wise, we assume demand for COVID-19 molecular tests in 2023 remains at similarly low levels to that of seasonal flu. This is partially offset by higher assumptions for diagnostics growth as healthcare utilization normalizes. Thanks to legislative action, the PAMA-led cuts to the Medicare clinical lab fee schedule have been granted a reprieve until 2024. Further, we’ve baked in less steep cuts in the second round of three-year reimbursement resetting, as more hospital-based labs are included in the Medicare calculations. We estimate top line growth at an average annual rate of 2.2% after 2024, following the spinoff of drug development in 2023. Unshackled from the lower-margin CRO segment, we anticipate LabCorp can improve operating margin by roughly 500 basis points in 2027—leaving the firm close to its pre-Covance acquisition operating margin in the mid-to-high teens.