Medical Labs and Research: Not Much Opportunity For the Longs

Our interest in the Medical Labs and Research Industry started with my father’s investment in Spherix (SPEX). The company seemed speculative and I wanted to get an assessment of SPEX’s value. While developing our valuation spreadsheet we realized that this industry is not of much interest currently. There are some discounts to be found, but other industries offer greater opportunity.

Investment Thesis

Investors interested in this space should focus on the companies listed at the end of the article as best values. The issues listed as undervalued at the end of the article seem to be undervalued by 30% on average. All values are small / micro cap stocks with the exception of Quest Diagnostics, making this industry the domain of those who are comfortable with greater than average risk.

Most Interesting Players

1.) Quest Diagnostics (DGX): almost anyone who has a full-time job has come across this company through their main business diagnostic testing. They perform a pre-hiring test that many people fear taking - urinalysis. The company owns and operates nearly 2,000 service centers across the US. The current market cap makes each center worth about $5.3M each, while only $3.12M in revenue is generated per center.

2.) National Dentex Corporation (NADX): this company is also one that many investors will are unwittingly familiar with. If you have ever had a cavity or know someone with "falsies" (false teeth), the cavity was probably filled and the dentures produced by National Dentex. NADX is compelling because it trades slightly above its $15+ book value.

3.) Alliance Imaging, Inc. (AIQ): this company is a supplier of MRI equipment to hospitals and medical centers.

4.) Aeterna Zentaris (AEZS): this is an interesting biopharmaceutical play. They discover and develop oncology and endocrine therapy focused drugs. Their two most promising drugs are Cetrorelix and Ozarelix. Cetrorelix helps curb sex hormones and assists with in vitro fertilization. Ozarelix is a Phase 2b trial drug with hopes of being used to treat prostate cancer.

Industry Metrics

Table 1: Key Financial Metrics for the Medical Labs and Research

The industry averages suggest that the Medical Labs and Research Industry is overvalued. These metrics seem pricey in terms of other industries and the over all market. Investors should focus on the poor showing of management in this industry. Returns on Assets, Equity, and the Capitalization rate are all lackluster. Interested investors might watch for management changes before purchasing any shares.

Valuation

Table 2: Average Per Share Values for the Medical Labs and Research

nvestors can quickly see that the industry as a whole is no bargain. From a valuation standpoint, the industry should be watched rather than bought. There seem to be a few turnarounds afoot, i.e. eResearch Technology (ERES), but for the most part shares in this industry are over valued. The price to sales metric offers investors a substantial discount, but the majority of other metrics are over valued. Finally, the industry has a poor showing on earnings power value versus reproduction value. This suggests that the underlying assets of these companies might be too expensive.

Financial Health

Table 3: Altman Z Score for Selected Medical Labs and Research

Those looking for a more risky proposition will be attracted to Alliance Imaging, Inc. and Aeterna Zentaris. These companies provide a poor showing from a financial health standpoint, which is supported by lackluster management performance. National Dentex does a little better, but shows average management. Finally, Quest Diagnostics seems to be the safest of all with an Altman Z Score of 4.22. Such a score suggests that investors in Quest can rest assured that financial distress will not occur.

Best Values

1.) National Dentex Corporation (NADX) – 35% discount to fair value
2.) Alliance Imaging, Inc. (AIQ) – 34% discount to fair value
3.) Aeterna Zentaris (AEZS) – 35% discount to fair value
4.) Quest Diagnostics (DGX) – 22% discount to fair value
5.) Psychmedics Corporation (PMD) – interesting earnings growth
6.) eResearch Technology (ERES) – turn around play

Disclosure: The author holds no shares in any companies mentioned in this article. He is currently long: Agilent Technologies (A), Verigy, Ltd. (VRGY), ConocoPhillips (COP), Brasil Telecom Participacoes S.A. (BRP), and ChipMOS Taiwan (IMOS).