Laboratory Corp. of America (LH) bought contract-research firm Covance for $5.7 billion last year, and 2016 could be the year where the deal really begins to pay off.
Clinical labs like Laboratory Corp. and Quest Diagnostics (DGX) have traditionally been slow-growth companies. These firms fight for reimbursements from insurance companies, hospitals and Medicare officials who are all hell-bent on keeping testing costs down.
As a result, Quest's 2015 revenues rose just 2%. And while Laboratory Corp. processes some 500,000 patient specimens a day, its sales only grew by 4%. LH hopes to really accelerate top-line growth through its purchase of Covance, a leading contract-research organization (CRO).
Pharmaceutical firms hire CROs to do the nitty-gritty work of lab testing and clinical-trial management during drug development. Contract-research organizations generate the safety and efficacy data that pharmaceutical firms provide to the U.S. Food and Drug Administration and the scientific community.
Covance was involved in developing all of the top 50 drugs on the market today. In fact, the company collaborated on 87% of the 45 drugs the FDA OK'd in 2015, including 100% of all approved oncology drugs.
Because of its critical importance to the industry, Covance has faster revenue growth (7% to 8%) than Laboratory Corp. as a whole does. But by merging the two companies, LH hopes to leverage its 100 million "patient encounters" to find new revenue sources for the CRO.
For instance, Covance has won more than $130 million in new business since the fourth quarter by using LH's treasure trove of patient data. The CRO has also already signed up more than 30,000 patients who want to be contacted about future clinical trials.
As for Laboratory Corp.'s core testing business, that can provide doctors with new insights by using Covance data to support better clinical outcomes.
For example, LH has delivered more than 5 million enhanced-diagnostic reports that improved doctors' adherence to national guidelines that call for better laboratory monitoring of chronic diseases. As a result, Laboratory Corp.'s nephrology unit saw as much as an 88% increase in physicians ordering additional tests for patients suffering from chronic kidney disease.
It all adds up to better top- and bottom-line growth for LH. Management predicted in March that fiscal 2016 revenues would grow 7.5% to 9.5%, while adjusted earnings per share would add 7% to 12% to between $8.45 and $8.85. Besides the better growth profile, the merged company should also manage to reduce expenses by $100 million over the next three years.
All told, analysts' consensus estimates call for Laboratory Corp. to ring up $9.68 in earnings per share for fiscal 2017. Since LH has historically traded between 14x and 16x forward earnings estimates, it's pretty easy to see the stock testing $140 a share from about $129 today if you simply apply a 14x multiple.
The bottom line: With an essential place in clinical testing and pharmaceutical development, Laboratory Corp. looks to me like it's medically necessary for your portfolio.