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Quest Diagnostics, Inc. - A Wax Ink Raw Value Short Report



June 28, 2009 – Comments (0) | RELATED TICKERS: DGX , GSK


The top guy makes almost $1.2 million a year, yet can't afford $6K for an alarm system. The company paid one executive more than $18K to relocate at the same time it was laying off rank and file employees, and the board of directors contains a retired employee from a company that owns more than 16% of this company. Yet the board has declared him independent. But the most impressive thing was that the company vice-president's compensation included $65 for use of the company aircraft.

How It Got Here

Financial information contained in this report is based on the company's Form 10-K filing for the fiscal year ending December 31, 2008, as filed with the Securities and Exchange Commission on February 17, 2009.

The Company

Quest Diagnostics, Inc. (NYSE: DGX) is the world’s leading provider of diagnostic testing, information and services, providing insights that enable patients, physicians and others to make decisions to improve health. The company, with its leading position in most of its domestic geographic markets and service offerings, is well positioned to benefit from the long-term growth expected in the industry.

Over 90% of the company's revenues are derived from clinical testing with the balance derived from insurer services, clinical trials testing, diagnostic products and health care information technology.

Clinical testing is generally categorized as clinical laboratory testing and anatomic pathology services. Clinical laboratory testing is performed on blood and body fluids, such as urine, while anatomic pathology services are performed on tissues, such as biopsies, and other samples, such as human cells.

With the acquisition of AmeriPath Group Holdings, Inc. in May 2007, the company has become the world’s premier cancer diagnostics company, focused on anatomic pathology including dermatopathology and molecular diagnostics and is now able to provide interpretive consultation through the largest medical and scientific staff in the industry, with approximately 900 M.D.s and Ph.D.s primarily located in the United States.

In addition, the company is the leading provider of gene-based testing and other esoteric testing, risk assessment services for the life insurance industry and testing for drugs-of-abuse. The company is also a leading provider of testing for clinical trials.

The company’s diagnostics products business, which includes the operations of HemoCue, Enterix and certain of Focus Diagnostics’ operations, manufactures and markets diagnostic test kits and specialized point-of-care testing. Through its MedPlus subsidiary, the company empowers health care organizations and clinicians with state-of-the-art information technology solutions that can improve patient care and medical practice.

The company was incorporated in Delaware in 1990, with its predecessor companies dating back to 1967. The company conducts business through its headquarters in Madison, New Jersey, and its laboratories, patient service centers, offices and other facilities around the United States, and in selected locations outside the United States.

During 2008, the generated net revenues of $7.2 billion and processed approximately 150 million test requisitions.

Investment Considerations

We have the company on our watch list with a Reasonable Value estimate of $81.50, a Buy Target of $40.75, a First Sell Target of $79.50, and a Close Target of $86.00.

In short, we are not nearly as impressed with management, as management seems to be with themselves.

As noted in the company's filings, 70% of the company's total assets are made up of Goodwill and Intangibles which we value at $0. When we reduce the company's Total Assets by the amount of the Goodwill and Intangibles, the company's adjusted Total Assets drops from $43 per share to $13 per share, or slightly more than half of the company's $25 per share of Total Liabilities.

Given these numbers, it came as no surprise to us that Total Debt was 3.5 times Net Fixed Assets, just as it came as no surprise to us that Total Debt was more than twice EBITDA. Given this information, what came as a surprise to us, especially given the poor worldwide economic climate of the last 18 months, was that banks would loan this company a dime.

With all that has gone on in the banking world of late, and given that should the company default on its loans a lender would not have the faintest idea how to reasonably value the evaporative assets they took in exchange for their tangible assets, we are simply amazed that lenders would even consider talking to this company about anything other than a cotton swab.

Admittedly we are not impressed with banks or bankers, believing they exist only to exploit borrowers for the banks own gain, which is exactly what we think the lenders to Quest Diagnostics will continue to do. The company ended fiscal 2008 with a Current Ratio below 2.0, a Quick Ratio below 1.5, and a Cash Ratio below 0.65, which are all metrics that bankers use to determine the creditworthiness of their corporate borrowers. And yet, the company does not report any negativity in its ability to borrow. Amazing.

We have long held that banks have a fiduciary responsibility to their corporate clients to fairly and objectively review the borrower's business plans and financial statements when considering borrowing requests, and to say no when no is appropriate. It is our opinion that is not what is happening in the case of Quest Diagnostics.

We note that while Free Cash Flow for fiscal 2008 stood at $3.80 per share, only $0.18 of that Free Cash Flow was moving to the Equity section of the Balance Sheet.

In addition, we note that the company ended fiscal 2008 with a Tangible Book value of ($11.62) per share, Earnings per share of $4.08, Shareholder Equity of $18.39 per share, and based on a recent close of $55.25, a trailing twelve month PE of 13.5.

Analysts have pegged earnings growth for the company over the next 5 years at 8.5%, and management has stated that the company's strong cash generation, balance sheet and credit profile, will position it to take advantage of growth opportunities as they arise".

We think that management should pull its collective head out of its collective rear end and take another look at is "strong cash generation and balance sheet". We simply don't see the strength.

Short-Term Investment Opinion

As a short-term investment, the stock of this company, while currently in an uptrend, is, or soon will be, overbought. With only a 9% spread between a recent close of $55.25 and First Resistance, and a 6% spread between a recent close an First Support, we do not believe a short-term investment is warranted at this time.

With Second Resistance at $48.83, a 12% decline from a recent close, we believe that world wide political events, market volatility, and no real understanding of how, if at all, the Obama Adminstration's health care reforms may impact earnings, are all telling investors there is simply far to little reward available for a short-term trade at this time.

We just hope short-term investors are listening.

Long-Term Investment Opinion

The problem with opinions is that like "other things", everybody has one. We of course are no different, however, our long-term investment opinions are intended to help investors keep that part to which "other things" is attached.

Accordingly, we are simply unimpressed with Quest Diagnostics as a viable investment at this time.

In our opinion, we simply do not believe that management has been paying attention. We also believe that management is aware that they have not been paying attention, and further, that management knows that contrary to an earlier statement, the company's Balance Sheet is actually a large piece of bull feces. The question is, how does management correct past mistakes.

Based on our perception of what we read, it is our opinion that management is going to attempt to improve the company's Balance Sheet through acquisitions.

It is further our opinion that this approach will fail, and that by the time the collective egos of management admit that this approach has failed, the company will be on the edge of obscurity, and Mr. Surya N. Mohapatra, Ph. D. will have flown off into the sunset on the company airplane.

So, based on the financial metrics that are important to us, and in full consideration of our understanding of the SEC filings listed in this report, our Deep Value Buy Target for the stock of this company is $19.00.

Quest Diagnostics, Inc. Worksheet 1208



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