Quest Earnings: Base Business Remains Solid, While Expanding Test Menu Should Reinforce Moat

Narrow-moat Quest Diagnostics DGX delivered second-quarter results that slightly exceeded our expectations on the top line, but that was offset by earnings that fell slightly short of our full-year estimates. Our fair value estimate is unchanged. Similar to the last five quarters, second-quarter demand for COVID-19 tests fell significantly (down 88% year over year), which should continue through the rest of 2023. However, absolute revenue from COVID tests has shrunk so much that the decline should have less of an impact on consolidated results. Additionally, recovery in the base business remains solid, with quarterly revenue up 9.5% from the prior-year period. Though we expect those outsize recovery rates to moderate as comparable quarters become more challenging, we think solid demand should support at least 2% revenue growth through 2024. If the proposed Saving Access to Laboratory Services Act supersedes the Protecting Access to Medicare Act, there may be mild upside to our revenue estimate for next year. Pressure on profitability could continue this year thanks to the tight labor market. Employee turnover has been a persistent challenge, and we wouldn’t be surprised to see this last into next year, even as macro indicators suggest more people seek to enter the workforce again.

We were pleased with Quest’s progress in building up its portfolio of proprietary tests that should reinforce its moat over the longer term. In particular, we like Quest’s plans to launch liquid biopsies to detect and monitor minimal residual disease among colorectal, breast, and lung cancer survivors. We peg the MRD target market opportunity could reach roughly $15 billion around 2030. While we expect Quest (and potentially Laboratory Corp. of America) to remain peripheral competitors to major liquid biopsy developers such as Guardant Health, we think there will be room for the labs to carve out a small slice of that market, just as they’ve done with BRCA tests for hereditary breast cancer risk.