LabCorp Earnings: Solid Demand Supports Robust Growth in Base Business, Aided by Ascension Deal

LabCorp LH delivered solid second-quarter results that offered the first peek into what LabCorp’s financials look like following the spinoff of the Fortrea drug development business. While the remaining biopharma lab services revenue is slightly smaller than we’d expected, this was largely offset by stronger growth in the diagnostic lab segment that we anticipate should continue through the year, as well as a slightly higher long-term earnings growth profile now that the lower-margin drug development business has been shed. As a result, we’re leaving our fair value estimate unchanged. We remain confident in LabCorp’s compelling cost structure that underpins its narrow economic moat. This firm has long been a superior operator in the reference lab industry, in our view. We expect this dynamic to become more evident again as the firm refocuses on diagnostic labs.

Underlying quarterly diagnostic lab revenue growth of 3.8% year over year reflected the steep drop in COVID-19 tests, and importantly, base business revenue rose 16% compared with the prior-year period, with a boost from the Ascension lab management deal. But, even adjusting for that agreement, the underlying diagnostic lab growth displayed strength. Considering medical utilization appears solid, we think the labs should see this recent strength to last through the year. Despite near-term spinoff-related expenses, we think LabCorp should return its operating margin to the mid to high teens by 2027.

We’re pleased to see LabCorp return most of the $1.6 billion windfall from the spinoff of Fortrea to shareholders in the form of share repurchases (timed well, as we view shares as slightly undervalued) and dividends. Considering the firm’s debt now sits around 2.6 times to adjusted EBITDA, we think the firm has plenty of financial flexibility to accommodate its ongoing tuck-in acquisitions.