We are lowering our 2020 estimates for DGX and LH to reflect COVID-19 disruption and lowering our 2021/2022 estimates to reflect recessionary assumptions, principally weaker volume growth and lower patient collections. Our estimates also now reflect changes to Medicare reimbursement (PAMA and sequestration), COVID-19 testing volumes, SG&A savings, and adjustments to capital deployment assumptions. Ex PAMA timing, forward EPS estimates decrease by ~10% and are ~10% below consensus for 2022. While valuation on our revised #s is below historical averages (both absolute and relative), the same can be said for most areas of healthcare services and we believe is justified by extremely low visibility over the next few quarters.
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As COVID-19 forces the U.S. population to increasingly shelter-in-place and the healthcare system to preserve capacity, it has become increasingly clear that there will be significant impacts on elective utilization, including physician office visits – which are the basis of most lab volume. DGX confirmed this by withdrawing 2020 guidance (expected) and noting that volume declines in the second half of March were in excess of 40%, inclusive of the benefit from COVID-19 testing. We think the declines are likely to grow as several other major cities unfortunately appear to be heading towards a NYC-like outbreak. We are still working through our models, but the initial implications for EPS are ugly – EPS could be down >50% given the high fixed-cost nature of the lab business.
Late last night the text of the latest Senate stimulus bill was released. The Senate has since passed this version of the stimulus. As it relates to labs, the biggest change vs. the initial Senate and House bills is to pause scheduled Medicare Clinical Lab Fee Schedule reimbursement cuts driven by PAMA for 1 year in 2021. We see this as a well-deserved win for the industry, which has stepped up to the plate to ramp COVID-19 testing capacity and will likely shoulder a significant NT burden from lost utilization as a result of social distancing / shelter in place. Assuming the stimulus bill is passed by the House and signed into law, 2022 will now be the last year of PAMA reimbursement cuts required by the current data collection. The benefit of incremental cash flow in 2021 is worth about 1% to each company’s current equity value.
Over the NT, both the amount of COVID-19 testing and the amount core testing volume deferred or lost remain extremely difficult for us to forecast – which we imagine is almost certainly true for lab management teams as well. We have put together a framework to assess the potential earnings at risk for DGX and LH. Our sensitivity model allows the user to make changes to different types of physician office visits (driver of most lab testing), client bill revenue, patient collections, and importantly factor in the benefit from COVID-19 testing. On the cost side, the user can specify incremental / decremental margins for each revenue stream and also layer in SG&A savings. The results are compared to our current estimates, which we have not yet adjusted and thus are still consistent with each company’s 2020 guidance provided in with Q4 results.
Following the introduction of the Senate Republican stimulus bill over the weekend, last night House Democrats introduced their own stimulus bill. In the House bill healthcare providers would have access to a $100B fund and an additional $80B in low-interest loans – this compares to $75B available to providers in the Senate bill. Despite the lab industry’s rapid response to increase COVID-19 testing capacity, there are no dedicated provisions in either bill providing relief to labs. The $100B is to be used “for making payments, through grants or other payment mechanisms, to covered entities to cover or reimburse health care related expenses or lost revenues attributable to the COVID–19 outbreak.” The House bill also qualifies that HHS “shall prioritize making such payments for charity care furnished, covered entities with high volumes of health care related expenses or lost revenues directly attributable to COVID–19”.
Given the highly uncertain outlook for earnings and cash flow this year as a result of COVID-19, we wanted to assess each company’s comfort level vs. financial covenants where applicable and benchmark liquidity vs. recent cash flows. In short, liquidity is 2-3x annual cash flow and the CROs average a ~45% EBITDA buffer vs. covenants.
As the reality of a COVID-19 pandemic sets in, the range of potential outcomes for the U.S. is being discussed in the context of the experiences of South Korea and Italy. South Korea is viewed as the best-case scenario for how to control an outbreak and flatten the curve, while Italy’s outbreak paints a sobering picture of how quickly caseload can intensify and overwhelm the local health care system. The U.S. response to COVID-19 to date can only be described as inadequate. We are practically nowhere with testing, and our current testing capacity is significantly below South Korea and Italy on a per capita basis. Clearly, the clinical labs will have to be a big part of getting U.S. testing capacity to required levels. However, we remain concerned that any benefit from this testing may be offset by loss of core testing rev as services are deferred – although to be fair having anything at all “positive” to come out of this situation puts the labs in a fairly unique position.
Following up on our note yesterday (03/09/20) on COVID-19 datapoints, last night the CDC began posting the # of specimens tested by the CDC and 49 of the 78 public health laboratories that have testing up and running. To date the CDC has tested 3,698 specimens and this subset of public health labs have tested 4,856 specimens. Assuming 2 specimens per person implies that 4,277 people have been tested by these labs. Interestingly testing by the CDC has slowed dramatically and is actually 0 over the past 3 days – see page 2 for the breakdown – this may be due to a reporting lag, although we note the most recent non-0 specimen counts are still well off peak. This reporting does not include testing from clinical labs like DGX and LH and it is not clear whether it will eventually do so. There continues to be low visibility into how much testing will be performed by the CDC vs. public health labs vs. clinical labs.
We have received numerous inquiries on what COVID-19 datapoints we are tracking and thought it would be helpful to publish a handful of links.
Yesterday a trial date was set for the opioid multidistrict litigation (MDL) Track 2 bellwether case in West Virginia following a status conference. Recall that the Track 2 bellwether case consists of Huntington, WV and Cabell County’s cases against ABC, CAH, and MCK. The trial is scheduled to begin on 8/31. Both the plaintiffs and defendants will have 6 weeks to present their cases, and inclusive of breaks in the schedule the case would run through the week of 12/14. Plaintiffs wanted the trial to start almost immediately, the and defendants had argued that a trial before the summer of 2021 “would be rushed”.
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