LabCorp Adjusts to New Normal Following COVID-19

LabCorp delivered full-year performance that generally hit our projections, with revenue of $14.9 billion hitting our estimate nearly on the nose. Although operating expenses were slightly lower than we’d expected, this had an immaterial effect on our valuation, and we’re holding steady on our fair value estimate. With the spinoff of LabCorp’s drug development arm on the horizon (now formally known as Fortrea), we think the remaining diagnostics business can still easily justify LabCorp’s narrow economic moat on the basis of cost advantage. LabCorp, along with Quest Diagnostics, will still be the two largest labs, by far. We see no factors that would impinge upon LabCorp’s ability to conduct tests that, on average, amount to roughly one third of what they cost at the hospital-based lab.

The fourth quarter displayed some of the same gyrations we’ve seen throughout 2020 and 2021—when the viral spread surges, demand for COVID-19 PCR tests rises and nonpandemic test revenue falls. The reverse occurs when COVID-19 recedes, which is what we saw in fourth quarter. Quarterly COVID-19 test revenue fell 21% year over year, partially offset by organic nonpandemic test revenue rising 6%. With COVID-19 largely in the rearview mirror, management’s outlook assumes COVID-19 PCR revenue will decline 75% to 90% in 2023, while base business sales should rise in the mid- to high-single-digit range, driven by organic growth with topspin from acquisitions. Overall, our estimates for 2023 remain bounded by LabCorp’s outlook, and we’ve made only minor adjustments through the midterm. With COVID-19 PCR tests accounting for a much smaller proportion of diagnostic revenue (which we peg around $165 million) in 2023 and the end of the pandemic public health emergency in May (which will slice reimbursement roughly in half), we anticipate operating margin normalizing in the 11% to 12% range this year, with some potential to rise once Fortrea is spun out.