Labcorp Holdings

LabCorp delivered second-quarter revenue of $3.73 billion, up 4% organically on solid volume growth and favorable price/mix. Quarterly earnings of $299 million rose 26% year over year thanks to tight control over operating expenses.

Why it matters: Considering the shrinking pool of ACA insureds due to the loss of exchange subsidies, we remain wary of signs that medical utilization has begun to soften. However, LabCorp and Quest's quarterly results still point toward solid utilization. Though we're still watching the situation carefully, management's view that bad debt expense has not shifted notably gives us some reassurance that reference labs have yet to see any impact from the lower rolls of insureds. Having said that, hospitals have indicated that they are seeing more uninsured patients. With the time in billings and collections, it might be that the reference labs could see a rise in bad debt expense in the quarters to come.

The bottom line: While management raised its 2026 outlook, our projections for the full year remain bounded by the new guidance, and our slight adjustments did not materially shift our $293 fair value estimate. We remain confident in LabCorp's narrow economic moat and see little on the horizon that would threaten the firm's significant cost advantage over smaller independents and hospital-based labs.

Long view: Both LabCorp and Quest have benefited from the proliferation of tests and screening guidelines that have expanded tests. LabCorp management alluded to oncology patients as one group that requires significantly more tests for treatment and monitoring. That group may offer one dramatic example, but we think the same applies to an aging population and those who develop chronic diseases. For instance, current test guidelines suggest six lab tests for the average 55 year old with no chronic conditions, while the number can balloon to 37 tests for the 80 year old with heart disease, neurological deficits, and abdominal pain.

Though these doctor-ordered tests still account for the vast majority of LabCorp's test volume, we're intrigued by the growth in direct-to-consumer tests that have begun to take hold over the last few years as state regulations on ordering lab tests have loosened. Both LabCorp and Quest have discussed the opportunity for consumer-directed healthcare to encompass lab tests for a very long time, and the market has now evolved to a point where we see a new stream of revenue for the big labs. LabCorp now offers tests on approximately 200 biomarkers, and consumers can buy the tests and book their appointments online. In the second quarter, LabCorp On Demand revenue grew in the double digits, though it remains a relatively small contributor to consolidated sales. Nonetheless, we think uptake of these tests is in the early days and expect to see increasing contributions over time.

We're holding steady on our $293 fair value estimate. We assume relatively optimistic projections for 2026 and 2027 that include ongoing cost-containment measures, test menu expansion, and topspin from the acquisition of hospital outreach programs and smaller labs.

We anticipate demand for covid molecular tests will fall to nonmaterial levels in winter 2026-27, similar to that of seasonal flu. The PAMA-led cuts to the Medicare clinical lab fee schedule have been extended to 2027. Further, we've baked in less steep cuts in the second round of three-year reimbursement resetting, as more hospital-based labs are included in the Medicare calculations. We estimate top-line growth at an average annual rate of 4% through 2030. Unshackled from the lower-margin CRO segment, we anticipate Labcorp can improve its operating margin by roughly 320 basis points in 2030.

In keeping with the longer-term trend, we anticipate faster growth in genomic and esoteric testing than in routine testing. Labcorp has done a good job of launching new complex tests, which leads us to believe that annual esoteric test volume should outpace market growth. We also think these specialized tests will carry a higher price tag than routine counterparts, resulting in an average annual price increase of about 1% over the long term. This will be offset by the reimbursement pressure on routine tests, which still make up the bulk of Labcorp's test mix by volume. We think some of Labcorp's investments in self-administered specimen collection and new artificial intelligence-enhanced robotic phlebotomy put the firm in a strong position to take advantage of emerging opportunities over the longer term.

Labcorp's narrow moat is based on its vast national infrastructure in its core diagnostics lab business, which translates into a considerable cost advantage over smaller regional labs in the independent reference lab industry, as well as hospital-based labs. With 34 primary and specialty testing labs and roughly 2,200 patient-service centers across the United States, Labcorp is able to run over 2 million tests each day at a substantially lower cost than most of the hospitals, doctors' offices, and smaller independent labs that populate the market. Labcorp and its main rival, Quest Diagnostics, account for approximately 25% of the US reference lab industry. The rest of that market is extremely fragmented, with many small independent labs as well as hospital-based labs.

Labcorp's ability to accommodate higher throughput and its extensive use of automation affords the firm a much lower cost structure—significantly lower than that of hospitals and smaller independent labs. This advantage also means Labcorp's model is characterized by substantial operating leverage. This operating leverage has worked against the firm in the wake of the Great Recession when healthcare utilization fell. However, as we saw over the covid-19 pandemic, the sharp acceleration in lab utilization also drove up profitability significantly.

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 producer (in place of the more expensive hospital-based labs) instead of pitting Labcorp and Quest against each other to eke out savings that also reduce patient access to lower-cost tests.

Payers prefer to negotiate with the largest reference labs, including Labcorp, that provide the best geographic coverage for the insured base, instead of cobbling together market-by-market coverage through multiple, smaller regional and local labs. In a departure from the exclusive agreements that used to characterize contracts with private payers, the larger managed care organizations have begun shifting to a different model that allows for both of the lowest-cost producers, Labcorp and Quest, to be in-network labs, with the intent of diverting test volume away from the higher-cost hospital-based labs.

Finally, Labcorp's scale and reach make it an attractive partner for researchers who invent various diagnostic tests but have no distribution channels through which to sell the tests. Labcorp has invested in a dedicated lab focused on companion diagnostics and has begun offering liquid biopsy technology for minimal residual disease in oncology patients. We view this as another indication that the firm is thinking more creatively about how to work more closely with other entities in the healthcare arena to stay on top of emerging diagnostic trends.

We don’t think Labcorp's biopharma lab services segment has dug a moat, as it does not compete in the moatier late-stage clinical trials where trial design and regulatory expertise can translate into intangible assets that foster sticky client relationships. In contrast, Labcorp’s BLS business is mainly focused on preclinical and early-stage toxicology studies where trial design isn’t critical. Further, the BLS segment also includes central labs, which is where diagnostic tests from later-stage trials designed and conducted by other contract research organizations are processed. This business is about volume, and Labcorp’s central labs do not offer any distinctive, defensible advantage over any competitive central labs.

From an environmental, social, and governance perspective, Sustainalytics pegs Labcorp's risk on the low end of the medium range, and we concur. ESG risk that could affect the moats for the largest independent diagnostic reference labs is generally low. Some of the most vulnerable areas of risk would include the high quality standards that labs must follow to ensure results are accurate and valid, as well as the possibility 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, Labcorp has robust, well-established processes in place to lower risk in both quality and billing. This stands in contrast with the smaller independent labs, which have been more likely to trip up on these dimensions.

There is new bipartisan legislation proposed, the Results Act, which would create a less onerous and more representative method to collect the private-payer reimbursement data to help set Medicare payment rates.

The more complex and labor-intensive esoteric tests are reimbursed at a higher rate and often outsourced by hospitals to independent labs such as Labcorp.

Labcorp has been able to keep less profitable capitated managed care contracts to a minimum, accounting for only 3.6% of 2024 diagnostic revenue.

If significant numbers of hospital-based labs are ill-equipped to comply with Medicare's payment reporting requirements, then reimbursement pressure could increase even more after 2026.

The expectation for smaller independent and hospital-based labs to fold under increasing reimbursement pressure has taken longer than anticipated to come to fruition.

If healthcare utilization and test volume soften, Labcorp's profitability could see accelerated declines.