Bio-Reference Laboratories - Solid Growth, Fair Valuation, Long-Term Opportunity


Bio-Reference Laboratories operates in a tough external environment with increased competition and lower reimbursements.

These factors are, however, stabilizing, creating less severe year-on-year headwinds.

Management is investing in future growth, thereby sacrificing short-term earnings.

The company has a very strong track record, making the valuation still appealing.

Bio-Reference Laboratories (BRLI) announced its second-quarter results on Thursday. Despite the fact that earnings fell compared to last year, they beat consensus estimates by a wide margin, triggering a huge rally in its stock.

Despite the big rally, shares continue to offer long-term appeal driven by smart investments, strong current growth and an excellent track record. If the company can close the margin gap with its competitors, much better times might be ahead for investors.

Second-Quarter Highlights

Bio-Reference Laboratories reported revenues of $201.4 million for the second quarter, up 14% compared to last year.

The company posted net earnings of $10.3 million, which is actually down by 9.1% compared to last year. As a result, GAAP earnings fell by four cents to $0.37 per share.

Adverse weather impacted earnings by an estimated $0.05 per share, which implies that earnings would have risen by a penny if not for the bad weather.

Despite the headline drop in earnings, investors were relieved and shares were sent more than 20% higher. Consensus estimates for earnings stood at just $0.32 per share.

Looking Into The Results

Revenue growth has been impressive, and Bio-Reference reckons that adverse weather actually reduced revenues by $5 million. Growth has been very impressive given the price pressure and tough competitive operating environment in the industry.

Gross margins were under pressure, compressing by about 1.7% to 44.0% of sales. Selling, general and administrative costs have been on the rise as well, increasing by 60 basis points to 34.6% of sales. Consequently, operating margins have been under pressure and have fallen to just 9.0%.

Topline growth has been solid, but margins are another story. Of course, poor weather impacted results, yet the changes in reimbursements and additional investments in Florida and California put pressure on earnings. The good news is that Bio-Reference sees most of the pricing pressure being a thing of the past.

As a national laboratory, the company has many contracts with large health plans with the likes of Cigna (NYSE:CI), Aetna (NYSE:AET) and Humana (NYSE:HUM). Changes through the Affordable Care Act have put pressure on the past year, although the company is optimistic that these tailwinds will disappear.

What About The Valuation?

Bio-Reference operates with some $24.5 million in cash and equivalents. The company has about $66 million in total debt outstanding, resulting in a net debt position of about $42 million.

At $32 per share, Bio-Reference is valued around $900 million. For the past year, the company posted revenues of $715.3 million, on which it earned $45.8 million. This values Bio-Reference's equity at just 1.3 times annual sales and 19-20 times annual earnings.

The challenge for Bio-Reference is to continue to gain scale and become more efficient. The company reports net earnings of just 6.4% of revenues. Larger competitor Laboratory Corp. of America (NYSE:LH) reported a 9.9% net margin for the past year, and trades at 17 times earnings, while reporting much slower growth. Quest Diagnostics Inc. (NYSE:DGX) reported net margins of 11.4% for the past year, and trades at 11 times earnings. Its revenues are, however, in steady decline in recent years.

While revenues are anticipated to grow further this year, earnings are under pressure for the reasons mentioned above. If the company can close the margin gap, a premium valuation based on the strong growth profile of the company might be warranted.

The company does not pay a dividend currently.

Transition Time

Recent growth in revenues has been fueled by a focus on specialty testing, genetics, cancer and women's health.

The expertise of GeneDx is merged with other offerings which fuel the company's competitive position in exome analysis, as well as in inherited cancer testing.

As such, the company is well-positioned for growth, while earnings have been under pressure as a result of the weather and all of these investments. This makes the current year a "transition" year in terms of profitability, as the company will keep a closer eye on expense reduction going forwards. Further growth should also allow for operating leverage and scale opportunities.

Takeaway For Investors

According to a recent investor presentation, Bio-Reference is the fourth-largest clinical laboratory within the US. Through the multiple market strategy, the company focuses on oncology, women's health, genetics and correctional health. Routine testing, the GenPath and, more recently, the GeneDx solution have been the product drivers behind growth.

The company still has a rather modest size, yet its track record has been impressive. Since 1995, Bio-Reference has grown its annual revenues at a compounded annual growth rate of 20%. The company posted revenues of just $30 million in 1995, and broke the $100 million revenue mark in 2003. If Bio-Reference continues to grow at current rates, it might break the billion-dollar revenue mark in a year or two.

Despite the growth, the shareholder base has only been diluted by some 5% over the past decade. Earnings have grown in line with revenues, as margins have not really expanded. Shares have been struggling as of lately, as reimbursements have been falling, while competition has been heating up, putting pressure on the company's earnings. Fortunately, the company expects that this pressure has been stabilized for the future.

While the fall in reimbursements is a relatively new phenomenon induced by the Affordable Care Act introduction, increased competition has been impacting the industry's profit margins for years. Instead of cutting investments back, like many competitors have done, Bio-Reference has actually boosted investments to be ready for future growth. This, of course, has temporarily pressured earnings. The impact of these investments can already be seen given today's impressive revenue growth rates at times when competitors are struggling.

I believe the solid growth and future investments warrant the current valuation. The company should be able to report revenues of $1 billion in one or two years' time, and if it manages to expand net margins towards 10% in line with competition, earnings should come in around a $100 million. A $1.5 billion valuation, or $55 per share, would not be unthinkable if this scenario materializes.

Therefore, I would anticipate shares to re-test all-time highs set around $38 per share. The solid growth and fair valuation makes it an acquisition target as well, in my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.