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Wells Fargo Resumes Coverage of LabCorp and Quest

NEW YORK (360Dx) – Wells Fargo today resumed coverage of the two largest clinical lab companies with an Outperform rating for Laboratory Corporation of America and a Market Perform rating for Quest Diagnostics.

Wells Fargo set a price target for LabCorp of $175 and a price target of $88 for Quest.

In a note to investors, Wells Fargo senior analyst Tim Evans described both companies as "relatively well positioned in an otherwise structurally challenged and commoditized industry." Wells Fargo is currently underweight-rated on the clinical lab sector as a whole.

Evans noted that due to ongoing price pressures, both LabCorp and Quest are unlikely to grow their diagnostic lab businesses by more than 1 to 2 percent organically. The bank gave LabCorp a 100 basis point growth advantage on revenue and earnings before interest and taxes because of its acquisitions of contract research companies Covance and Chiltern, which make up about a third of the company's revenue. Evans estimates that contract research is a 5 to 6 percent revenue growth business.

In the near term, Evans expects the recent hurricanes in Florida and Texas to weigh on third quarter earnings more heavily for Quest than for LabCorp. Medicare cost pressures, however, may be slightly less than feared in 2018, which is slightly better for Quest than for LabCorp, he wrote.

Overall Evans wrote that the outlook for longer-term pricing is still fairly pessimistic. Industry challenges faced by LabCorp, Quest, and other labs include lack of pricing power. Evans noted that despite the fact that the lab industry raised "valid objections" about the methodology used to set Protecting Access to Medicare Act prices for lab tests, the draft prices reflect near worst-case cuts.

"We think the industry's relatively modest size (compared to, say, the drug industry), leaves it with less clout in Washington," he wrote.

The industry also faces fierce competition because lab tests have limited intellectual property protection and because the way labs are regulated allows competitors to enter the market without significant regulatory hurdles. In addition, the challenge of getting reimbursements has resulted in both companies having bad debt running in the mid-single digit percentage of revenue, he noted.

"For complex tests, simply getting a reimbursement agreement with payers can be challenging," Evans wrote.

In late morning trading, LabCorp's shares inched up a fraction of 1 percent to $150.29 on the New York Stock Exchange. Quest's shares also rose less than 1 percent to $91.77 on the NYSE.