Introduction
An endeavor is made to evaluate Laboratory Corporation of America (henceforth referred to as Lab Corp.) using financial ratios and other valuation tools. All relevant ratios used in this write-up have been calculated in Step 1. The ratio-based analysis is made in respect of profitability, liquidity, efficiency, and financial structure of the company. In the next step, the company’s stock valuation is analyzed using factors and tools like ROE, EPS, Market/Book ratio, and Price/Equity (P/E) ratio. It was found that the P/E ratio was the best observant of the market value of the stock of the company. Thereafter under step 3, an analysis of the company is undertaken on the basis of factors like nature of services being rendered by the company, industry analysis, product mix, risk factors affecting its business, and the Swot analysis undertaken to find out the company’s strengths, weaknesses, opportunities, and threats. In the final analysis, it has been observed that the company is healthy, progressive, and worth investing in its stocks.
Financial ratio Analysis
Financial ratios of Laboratory Corporation of America calculated hereunder are based on financial figures provided in the statements shown in the company’s Annual Report 2007. Further ratios for the previous year 2006 have also been calculated in order to provide an internal comparison so necessary for perfect analysis.
Let us start with a profitability analysis of the company. It will be observed in the ratio table above that the company has operating profits margins of 19.1% in 2007 as compared to 17.42% in 2006. This increase has result basically because of an increase in net sales from 3590.8m in 2006 to 4068.2m. Also, the company has shown restrain and efficiency in controlling overheads in order to bring the increased operating results.
Return on equity (ROE) is also a profitability ratio that measures returns on the equity investments in the company. ROE has also increased from 21.83% in 2006 to 27.64%. This is a tremendous performance, and the reason for this is that the market price of the common share of the company has jumped from $73.47 as of Dec 31, 2006, to $75.53 per share. Considering the Return on assets (ROA), another profitability ratio, it will be observed that ROA has also shown an increase from 10.79% in 2006 to 10.92% in 2007. Accordingly, profitability calculated from three different angles of Operating margins, Return on equity, and Return on assets has shown a steady increase in 2007 when compared to 2006. Accordingly profitability wise the company has performed very well as compared to performance in 2006.
Liquidity
Liquidity reflects the solvency of the company and is measured through current and quick ratios. The current ratio of 2:1 is considered optimum for any organization, but it differs from industry to industry. The current ratio of Lab Corp. is 0.97 in 2007 as compared to 0.95 in 2006. This ratio is very poor in both the years and indicates that the company might be finding difficulty in meeting its current obligations as those become due. The same thing is again confirmed when its quick ratio is observed. The quick ratio is a part of the current ratio but uses only very quickly cash convertible assets into its calculations. The quick ratio of 1:1 is considered optimum, but Lab Corp. has poor quick ratios of 0.89 and 0.86 in 2007 and 2006, respectively. Overall the company has a very delicate position so far as liquidity is concerned. The company must make efforts to overcome this delicate liquidity situation.
Efficiency
The efficiency of a company can be measured through its activity ratios like Inventory turnover, OIROI, Total Assets Turnover, and Fixed Assets Turnover. Inventory turnover indicates how many times the average inventory of the company has been converted into sales. For Lab Corp., it has been done 29.56 times in 2007 and 24.45 times, and this is a remarkable feat. Similarly, Total assets turnover indicates the efficiency with which the company exploits its total assets. Lab Corp. turns over its assets 0.93 times in 2007 and 0.9 times in 2006. The company increased its asset turnover efficiency slightly in 2007 as compared to 2006. Fixed assets are part of total assets and play a major role in operating activities in any organization. The fixed assets of Lab. Corp. have been exploited 9.26 times in 2007 to bring in the achieved sales turnover, and this ratio was 9.13 times in 2006. So there is a marginal improvement over the performance of 2006. OIROI ratio indicates “the effectiveness of management at generating operating profits on the firm’s assets, in managing the firm’s income statement, and how efficiently a firm is using its assets in generating sales.” OIROI for Lab Corp. in 2007 was 0.18 as compared to 0.17 in 2007. The company has quite effectively managed its assets in contributing to operating profits. That is why operating profits had shown an increase from 17.42% of EBIT in 2006 to 19.1% in 2007. Though the increase in efficiency rate is marginal when we compare the different ratios of 2007 to 2006, the performance is quite effective in bringing the much improved operating results in 2007 as compared from 2006. Overall the company has quite speedily converted various assets into sales or inflow or outflow of liquidity and ultimately achieved good operating results.
Financing of company’s assets and capital leverage or gearing
Total assets of a company are financed either by equities or through debts. In this regard, two ratios play an important role in assessing the company’s financing status, and those are Debt ratio and Time Interest Earned Ratio.
The debt ratio presents the status of the firm’s total assets financing through its indebtedness and owned capital. Lab Corp. has this ratio of 0.61 in 2007 as compared to 0.51 in 2006. That means in 2007, more than half of assets are financed through debts. This also indicates the financial leverage of the company. As per debt ratio, the firm is high geared in 2007 as compared to 2006 when the company’s debts were almost equal to its equities. However, this position of capital leverage is more clearly indicated by the Total Debt to Equity ratio, which for Lab Corp. for 2007 is 0.54 in 2007 and 0.44 in 2006. Even as per this ratio, debts are more than equity in 2007. The company can be said to be slightly high geared. In 2006, the company was low geared when debts are lower than equity investments in financing the total assets of the company. Equity holders have the complete advantage of playing with gearing in 2007 as after meeting interest obligations, all profits belong to equity holders.
The Time Interest Earned ratio provides no of times the company has provided coverage to interest obligations. In 2007, the company had this coverage of 13.73 times. In 2006 it was 14.58 times. The equity holders of the company are better placed, and certainly, this factor would have provided a boost to the value of the stocks of the company.
Stock Valuation
Basically, the valuation of stocks of a company relies on the analysis of historical financial data, and in this regard, the ratios calculated and analyzed in step 1 above play a big role. The ratios that are important in valuing the stock of a company are those related to profitability ratios, efficiency ratios showing the speed with which the company is performing to achieve its objective, and its financial capabilities like debt ratio and time interest earned ratio. These all ratios have been analyzed in part 1 above. However, the yardsticks for valuation are Price/Earnings (P/E) ratio, Market/book (M/B) value, ROE, EPS, and dividend yield.
Return on equity has been calculated in the table in step 1 above, and accordingly, ROE for 2007 is fantastic 27.64%, and in 2006 it was 21.83%. The company is earning really well on equities when we see that industry best is 33.59% of ‘eResearch Technology Incorporation’ (ERES).
The company has EPS (basic) of $4.08 per share in 2007 and $3.48 per share in 2006showing a growth of 17.24%. A comparative figure in the industry is 153.30%, again of ‘eResearch Technology Incorporation’ (ERES).
The company has not declared or paid any dividends in 2007 and 2006.
The Price/Earnings (P/E) Ratio of the company is $18.51 and $21.11, and this has been calculated on the basis of the actual market price of the company’s common stock as of December 31, 2007, and December 31, 2006. These figures divided by EPS (basic) provide us respective P/E ratio stated above. P/E ratio, in fact, points out the amount investors are willing to pay for each dollar of earning of the company. It may be noted that the P/E ratio had dwindled from 21.11 in 2006 to 18.51 in 2007. This decline does not reflect the decline in confidence in the investors. In fact, the decline was due to a general trend set under abnormal market conditions that affected almost every company, and it was certainly not a performance base decline.
Market/ Book (M/B) value is another parameter to evaluate the stocks of the company and is achieved by dividing common stock equity by an outstanding number of shares. As per data provided at Yahoo.com, the book value of a share of the company as of December 31, 2007, is $15.3 per share.
Considering all aspects and factors of evaluating the shares, the best valuation is considering the P/E ratio because it takes into account the following factor:
- Earning per share based on actual performance,
- The market value of shares as on the date of valuation.
In the case of Lab Corp., the P/E ratio of $18.51 reflects that investors are ready to pay $18.51 for one dollar of earning per share of the company, and this is the best evaluation based on available market and company data, and also when we compare it with a book value of each outstanding share.
Company Analysis
For making an all-round company analysis with regard to its performances, industry standing, and effect on its stock valuations (as considered in part 2), the analysis and repercussion of the following factors are important:
Company Description
Laboratory Corporation of America, established in 1971, is clinical testing laboratories that provide services for making various clinical tests ranging from regular blood and urinalysis testing to high profile HIV and microbiology tests. The company basically caters to physicians, hospitals, government agencies, employers, pharmaceutical companies, independent laboratories, and others. The company has 37 primary laboratories and approximately 1600 patient service centers.
Industry Analysis
The revenue growth in 2007 with Lab Corp. as compared to 2006 was 13.29%, whereas the industry’s highest revenue growth rate has been shown by Genoptix Inc. of 109.40%.
It is true that the rise in revenue has given the increase in net earnings of the company, and thereby EPS (basic) has gone up from $3.48 in 2006 to $4.08 in 2007, giving a growth rate of 17.24%. On the other hand, industries highest EPS growth rate is 153.30%; and Lab Corp stands at no. 4th out of 21 firms considered for the ranking. Growth in Return on equity as per ratio calculated in part 1 is 26.61%, and when compared to industries highest EPS growth rate of 33.59%, Lab. Corp. stands at 3rd in the ranking. The company has not declared any dividend when the industry dividend growth rate is 4.10%.
From the above comparisons with the industry, it appears that besides attaining a position of 3rd rank in EPS growth, Lab Corp. is nowhere to the industry big wigs, and it will require some change or enthusiastic strategic planning in the objectives of the company to stand good in ranking among the leaders of the industry.
Product Mix
As stated earlier, the company’s main operations are clinical laboratory testing. Therefore, the company may not be in a position to make a deliberate attempt to boost its revenue through the marketing technique of product mix. But there is always a way out when the laboratory making clinical analysis gain control of a specialized technique of testing or using innovative techniques to come up with certain clinical tests that are not or rarely performed by other laboratories. As per the company’s Annual report 2008, “The increase in net sales for the three years ended December 31, 2007, has been driven primarily by volume growth in the Company’s managed ‘Medical Care business,’ the impact of acquisitions and the companies continued shift in test mix to higher-priced genomic and esoteric tests.” As a result of this mix of growth in medical care business, acquisition of companies, and shift in test mix, the company has achieved a revenue growth that accounted for around 1/3rdtoles in the industry in genomic and esoteric test market from 2005 to 2007. This is a very important factor contributing towards the company’s growth while considering its analysis.
Risk factors
The major risk factor affecting the growth is seasonality like year-end or other seasonal holidays. M D & A of financial analysis at page 20 of Annual report 2007 clearly discounts this as a major factor. The report states that “The majority of company’s testing volumes is dependent on patient’s visits to Doctor’s offices and other providers of health care. The volume of testing generally declines during the year-end holiday periods and other major holidays. In addition, the volume declines due to inclement weather may reduce net revenues and cash flows.” (Annual Report 2007, page 21)1b. These risk factors certainly affect the financial results and thus have a bearing on company analysis.
Swot Analysis
Strengths
The basic strength of the company is its rising revenue, and that will gain further strength because of the following two factors:
- The company executed a multi-year contract with ‘CIGNA Healthcare’ whereby the company will be a contracted laboratory in CIGNA markets.
- The company has become a non-participating laboratory provided under an agreement with Aetna Inc. with effect from July 1, 2007
- The company has also entered an agreement with Humana Inc. in 2007 to provide access to the company’s laboratories to Humana members in all Humana’s markets.
Weaknesses
The company is facing a cash crunch, as is reflected by its very delicate current ratio and quick ratio calculated in Step 1 above. This might affect the regular supplies for testing whenever the company is unable to meet its current obligations when those become due.
Opportunities
The company can execute its earlier scheme of acquisitions of laboratories by raising long-term debts as the company is almost lowery geared so far as its capital structure is concerned. The company can repeat the feat of increasing revenues as it had between 2005 to 2007 using acquisition as product mix as earlier stated in this write-up.
Threats
The company may be facing threats from its competitors like ‘eResearch Technology Inc’ and Genoptix Inc., as those companies are leaders in the industry so far financial performances are concerned. But there is cause for relief as they do not yet cater to a large and well-scattered market.
Overall assessment
Taking into account all factors stated above, it can be stated that Lab Corporation of America has already captured a market of its own by entering into various revenue-boosting agreements. Though certain market factors like P/E ratio has dwindled when compared to last years, this was not because of any failures on the part of the company, but as a result of market trend. The company has more strong points as per Swot analysis than its weaknesses and threats. There are hardly any other risk factors except the seasonality factor. The company has also used the technique of acquisitions of laboratories in its effort to enhance the revenues successfully. Thus the company is on a path of success, but it has to take care of the delicacy of liquidity emerging into its systems.
Conclusion
Laboratory Corporation of America is mostly a success story as per the evaluation of its financial data and other considerations. There are minor snags of liquidity that can be easily captured by adopting a suitable fiscal policy. The market value of its stock is very respectable except for a slight decline reflected through the P/E ratio of 2007 as compared to 2006, but this is not due to any shortcomings at the company’s end. There was a trend that dissuaded individual investors from the market because of uncertainty created by big market players. The company is growing and worth investing in its shares as signs indicate that Laboratory Corporation of America is going to be the story of success in the coming years as well.
References
Annual Report 2007 of Laboratory Corporation of America, Web.
Keown J, et all, Financial ratios, based on Financial Management, Chapter 3:, Evaluating a Firm’s Financial Performance, Web.
Industry and some company information taken from Yahoo.com, Web.