Quest Diagnostics

Quest reported second-quarter results that included revenue and adjusted earnings per share growth of 10% and 19%, respectively, with strength across the hospital, physician, and consumer segments. Shares are up 7% at time of writing.

Why it matters: Hospital operator HCA's warning last week that the expiration of individual subsidies would put pressure on its 2026 profitability was taken as a shot across the bow for those industries that sell to hospitals, including diagnostic labs. Quest's impressive second-quarter performance provides some reassurance that any anticipated impact from the rising uninsured population has yet to materialize. Management indicated core hospital reference lab revenue and volume remain solid with mid-single-digit growth. Even among exchange-insured this quarter, tests per requisition rose 6%, which softened the 8% decline in requisition volume. This is consistent with our sense that the healthier people have forgone individual coverage as premiums have risen, while those who remain insured are less healthy.

The bottom line: We're raising our fair value estimate to $204 per share, up from $184. Roughly half the increase is due to our more optimistic view that Quest's current strength can be maintained through this year, and the other half is driven by time value of money. In particular, we expect Quest's collaboration with Corewell Health to support healthy growth in requisition volume into 2027, while the profitability of this program should also rise in that time frame as the new central lab in metro Detroit opens early next year. We think this arrangement with Corewell, which is the largest integrated delivery network in Michigan, could be instructive to other providers entertaining the concept of outsourcing more of its lab management and operations.

We remain wary that the rising uninsured population could weigh on medical utilization, perhaps not in the next quarter, but beyond that. Thus far, Johnson & Johnson, Abbott, and Quest have all provided a consistent view that demand hasn't seemed to soften appreciably. Nonetheless, medical utilization roared in 2024 and 2025. With fuel and food costs up recently, questions about when this financial pressure might cause patients to delay or forego care have loomed large in investors minds. We think these concerns could leave medtech and reference lab shares exposed to some volatility in coming quarters.

We're standing behind our fair value estimate of $204 per share. We expect that recent strengths in test volume can be maintained through 2026, aided by aggressive renegotiation of contracts with commercial payers to capture price increases. However, we hold more tempered expectations for the following four years as we anticipate some contraction in the insured population. This leads to our estimate for organic annual revenue growth of roughly 4% through 2030. We assume operating margins will expand steadily by roughly 300 basis points to 17% in our explicit forecast period.

During the height of the pandemic in 2020 through 2022, the PAMA cuts scheduled for 2021 were suspended, offering a bit of breathing room to the labs. Then, Congress took action at the end of 2021 to further delay the next reimbursement rate-setting cycle to 2022. This was followed by more delays in 2023, 2024, 2025, and 2026. In the most recent delay, implementation of the next round of PAMA cuts has been pushed off until 2027. This respite from PAMA cuts provides some stability in prices. If Congress can act on the proposed RESULTS legislation, it would reduce the prospect of another round of substantial PAMA cuts and put adjustments to Medicare reimbursement on a more gradual path. However, we're not particularly hopeful Congress can accomplish this by end of year.

Over the longer term, we think the company's focus on esoteric test business will pay off. With pharmaceutical and biotech companies aiming for personalized and targeted therapies, we expect a steady stream of new biomarker discovery and greater application of molecular diagnostics across the clinical spectrum. The latest development of blood tests to monitor for minimal residual disease among cancer survivors offers a new market to labs. This bodes well for Quest.

Quest's narrow moat is based on its vast national infrastructure in its core diagnostics labs business, which translates into a considerable cost advantage over smaller regional labs in the independent reference lab industry, as well as hospital-based labs. Compared with those other players, Quest offers compelling cost advantages thanks to its scale and volume. For example, tests at hospital labs typically cost 3 times more, on average, than the same test at Quest. This advantage becomes even more pronounced when throughput increases and translates into attractive operating leverage. Quest handled 244 million requisitions (each requisition often contains multiple tests) in 2025.

Additionally, the firm's nationwide footprint with an extensive network of 2,400 patient service centers and in-physician office services would be difficult to replicate from scratch. Quest's advantageous cost structure and national coverage are also appealing to the payers that structure reimbursement and policies to funnel patients to the large independent labs that offer lower prices. Payers would typically rather negotiate with the largest reference labs, including Quest, that provide the best geographic coverage for the insured base instead of cobbling together market-by-market coverage through multiple smaller regional labs.

We've seen large payers, including UnitedHealth and Elevance, begin to more assertively flex their muscle to direct more insureds to the lowest-cost labs and challenge the significantly higher prices that hospital-based labs demand for diagnostic tests. We wouldn't be surprised to see this trend continue as payers seek to lower medical costs. Finally, Quest's scale and reach make the company an attractive partner for the researchers who invent various diagnostic tests but have no distribution channels through which to sell the tests.

Although we had seen more aggressive price competition between Labcorp and Quest Diagnostics in the early 2000s, pricing has remained rational over the last 20 years and is even less likely to become irrational now that payers have shifted to adopt payment reforms. We think this reflects the influence of value-based healthcare reform, in the wake of the Affordable Care Act. It has become more economically attractive for payers to encourage patients to use any low-cost provider (instead of more expensive hospital-based labs) rather than pitting Labcorp and Quest against each other to eke out savings that also reduce patient access to lower-cost tests.

From an environmental, social, and governance perspective, Morningstar Sustainalytics pegs Quest's risk as low, and we concur. ESG risk that could affect the moats for the largest independent diagnostic reference labs is low. Some of the most vulnerable areas of risk include the high-quality standards labs must follow to ensure results are accurate and valid, as well as the risk of getting caught up in Medicare fraud through incorrect or overbilling.

As we saw with the Theranos debacle, inaccurate test results can lead to inappropriate medical treatment. However, Quest has robust, well-established processes to reduce risk in quality and billing. This contrasts with smaller independent labs, which have been more likely to stumble in these areas.

Advances in technology and personalized medicine are increasing the number of complex esoteric and gene-based tests available to patients. These tests generally carry higher profit margins for Quest.

Quest has been actively seeking out hospital outreach programs to roll up. These acquisitions offer very attractive economics to Quest.

Though it is still early days for the adoption and reimbursement of Quest's molecular residual disease tests to monitor patients in cancer remission, we expect this will become standard of care over the long haul.

If declines in the insured population are substantial, the resulting hit to test volume could drag down profitability for Quest.

If the impending cuts to Medicaid cause hospitals to close, that could narrow the pipeline of potential lab acquisition and collaboration targets for Quest.

On an anecdotal basis, we have consistently heard complaints from patients about poor service at Quest service centers.