The Trader

The average investor is more likely to recognize Laboratory Corp. of America Holdings (LH) for its lab-test bills that come in the mail than for its stock, which closed Friday at about 82. Its ubiquity in American life is part of the attraction of the shares, whose price has been hit by what appear to be more short-term concerns than long-term difficulties.

Lab Corp. is one of two big players: It has a 9% market share, and Quest Diagnostics (DGX) has 13% of the work done for things like blood tests and urinalysis, among others. The remainder of such tests are done in-house by hospitals or much smaller, independent labs. LH operates 51 large labs and 1,700 smaller labs, and is present in all 50 states,

The stock is down about 18% from a high of 100 this year. Quest is up about 8% over the past 12 months, compared with Lab Corp.’s 1% drop. Over the previous 10 years, Lab Corp. shares have outpaced Quest’s.

But, says Darren Pollock, a portfolio manager at Cheviot Value Management, a couple of issues have dented LH. Test volumes have fallen as patient visits dropped about 5% last year, and are weak this year, thanks to economic weakness and high unemployment. And, with Uncle Sam desperate to save money in places like Medicare, the specter of increased regulation and reduced payments has investors nervous.

Yet testing services generally reduce overall health-care spending, Pollock observes. Medicare/Medicaid revenues are about 20% of Lab Corp.’s business. With, say, a 2% decline in reimbursement, LH’s total revenue would slip by 0.4%, he estimates. And instead of being a negative, health-care reform might even widen the base of potential customers by driving them from the higher-cost independents.

The price drop represents a buying opportunity, opines Pollock. Cheviot bought shares in October, at 76. LH possesses textbook advantages, he adds: large barriers to entry, high and sustainable profit margins, generous cash flow, a service that lowers health-care costs, plus fundamentals favorable for growth.

One wind at Lab Corp.’s back: the aging of the U.S. population.

Contracting with the lowest-cost labs is a way for health-care providers to save money. Hospitals charge more than three times the price, and independent labs roughly twice the price, for the typical test that LH performs, he says.

LH maintains a healthy balance sheet, consistently earns 14% to 18% returns on total capital, and 11.4% net-profit margins. Quest’s return on capital is 10% to 11%, with net-profit margins of 8.9%. For a business with greater qualitative strengths, Pollock says, Lab Corp. should trade at a premium to Quest, but instead is changing hands at a discount. Its forward-price/earnings multiple is 11 times, while Quest’s is 12.

Give LH something like a Quest P/E, and the stock price reaches 95, he predicts.


The securities discussed in the posted article are current holdings of Cheviot’s clients. The viewer should not assume that investments in the securities identified and discussed were or will be profitable and it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. All information is provided for informational purposes only and should not be deemed as a recommendation to buy the securities mentioned. Cheviot closely monitors its positions and may make changes to the portfolio’s investment strategy when warranted by changing market conditions. If a security’s underlying fundamentals or valuation measures change, Cheviot will reevaluate its position and may sell part or all of its position. There can be no assurance that Cheviot’s clients will continue to hold the same position in companies described herein, and their portfolio positions may change at any time.
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