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Bio-Reference Labs (BRLI) is the largest independent clinical lab franchise in the northeastern United States, with a strong position in New York City. The timely stock’s major appeal lies in the company’s robust near-term earnings growth potential based on the driving force of positive recent trends. It also has a very stable risk profile, and due to rapid consolidation in the clinical lab industry, the company is a potential takeover target.

Strong near-term earnings growth

Late last year, a string of negative news articles called into question almost every aspect of BRLI’s operations, causing the stock price to fall precipitously. Since then, the company has strung together a necklace of very good quarters culminating in the most recent fiscal second quarter (ended April 30th). Bio-Reference handily exceeded the “Street’s”consensus  share earnings estimate of $0.30, by posting a diluted tally of $0.34, superceding the year-ago figure by 21%. We look for the third quarter’s (July) bottom-line figure (scheduled to report on September 8th), to also exceed last year’s total of $0.36, by 19%. Share earnings of $1.45 are likely this year (up from $1.29 in 2011), going up to $1.70 in 2013.

Spearheading the earnings drive is strong revenue growth, derived from the company spending more than twice what its larger competitors do on sales and marketing. Penetration of new geographies with new products supported by a highly efficient marketing machine, should continue to drive organic growth, while capturing market share from competitors. Share repurchases should continue, and management’s keen focus on cost controls ought to buttress earnings growth. Organic growth should also be enhanced by initiatives in BRLI’s specialized services business. In April, BRLI bought a 23% stake in InCellDx, a privately held molecular diagnostics company specializing in cervical cancer, breast cancer, HIV/AIDS, hepatitis, and organ transplant rejection. Commercialization of new tests and products is resource intensive, but Bio-Ref has the operating cash flow and funding to support such initiatives.

Solid financial profile

Bio-Reference sports an A+ Financial Strength rating. Its long-term debt as a percentage of total capital is only 6% (as of April 30th), and it has about $20 million of cash on its balance sheet.  Share earnings have been growing at a very high double-digit rate of 24% over the last five years, generating an abundance of free cash flow, which has been ploughed back into expanding the business.  Indeed, BRLI spawned free cash flow of $1.34 a share in 2011, and it’s expected to top that mark in 2012. Furthermore, the stock has a Price Stability rating of 70, a Price Growth Persistence mark of 90, topped off by an Earnings Predictability rating of 95. For a small-cap stock (market cap: $750 million), these are quality financial metrics. 

Potential takeover candidate

This is the kicker. Within the next year or so, we believe a strategic sale of the business will occur.  Commercial and government payors, looking to cut escalating health care costs, will increasingly pressure provider reimbursement which, in turn, is likely to further fuel laboratory testing industry consolidation. BRLI’s critical mass in the highly lucrative and populated TriState area, along with its expanding molecular diagnostic test menu, would likely interest regional Labs looking to expand their service areas, and bolster their offerings. Since September 2011, eight of Bio-Reference’s peers have been acquired. Of note, Quest Diagnostics (DGX) bought Athena Diagnostics for 6.7x enterprise value/sales (EV/S), and General Electric's (GE - Free GE Stock Report) GE Healthcare bought Clarient for 5.8xEV/S. We highlight these purchases simply because they were much higher than the average purchase price of 3.2EV/S. Based on these historical sales prices, we believe BRLI could be purchased from anywhere between $40-$75 a share. In addition, Novartis (NVS) bought Genoptix in January 2011, and Nestle SA (NSRGY) bought Promethius in May 2011. The frantic buying spree leads us to believe Bio-Reference may already be in talks to be acquired by a larger competitor.

Conclusion

Total shareholder return over the past three- and five-year periods has been 41.35%, and 47.7%, respectively. With the bottom line likely to grow at a 27% average annual clip over the span to 2015-2017, we think this is an excellent time for the majority of investors to jump aboard, particularly given the company’s solid financial strength. Moreover, speculators may be attracted to the equity as a buyout candidate, although we don’t advocate most investors solely buy the stock based upon this possibility.

At the time of writing, the author didn’t have any positions in any of the companies mentioned.