Shares of Bio-Reference Laboratories (BRLI) traded at 20.51 when we highlighted the company for the November 2010 newsletter. The small clinical laboratory has demonstrated steady sales and earnings growth, as well as industry-leading profitability stemming from a slate of esoteric, higher-margin tests targeting such areas as cancer, genetics, and women’s health. When we introduced BRLI to the Investor Advisory Service, the stock carried a premium P/E multiple compared to its larger, slower-growing competitors Quest Diagnostics and LabCorp.
After rising along with the broader market, shares took a big hit on May 23rd after Barron’s ran a negative weekend feature on the company. The article ran under the ominous headline "There Will Be Blood."
The old saying goes: "It takes two sides to make a market." In this case, our inclination is to stand on the other side against Barron's. Writer Bill Alpert drudged up some salacious material on CEO William Grodman's past, particularly regarding a procession of shady associates. A physician by training, Grodman's business instincts as a young man seem not to have been well-honed. Neither he nor Bio-Reference has been accused of wrongdoing.
Alpert noticed some financial peculiarities that we too had highlighted as risks in our original feature. Due to insurance reimbursement discounts, only 25% of gross billings translate to sales. On the private-pay (non insurance) side, the company carries receivables at full price. A lot of those customers won't pay, so BRLI credits a large bad-debt reserve against the asset, another point of concern for Alpert. The accounting treatment does not look improper to us. There’s probably a more conservative possible treatment, but we don’t see why Barron's makes a fuss about the point.
Customers' slow pay behavior causes BRLI to accrue large receivables balances. With such huge receivables balances, it is difficult for the company to generate free cash at it grows. As long as BRLI continues to grow at a double-digit rate, working capital will continue to eat up cash. When the company’s growth eventually tops out, and it starts to look more similar to its larger competitors, it should begin to throw off cash like they do as well.
Alpert insinuates that BRLI bills for unnecessary molecular tests. CEO Grodman points out that the alleged tests are neither unnecessary, nor even a significant share of the company's overall revenue. Investors appear to be lending some credence to the bear case. The first day's price drop was only about 6%, but the market's attitude toward the company thereafter appeared to flip decidedly negative. June, July, and August saw a grinding decline during which shares came down almost 30%, from 25 to 18, in a path resembling a down escalator.
Growth has remained good for Bio-Reference, but the stock has undergone substantial P/E compression. Based on forward EPS estimates of $1.27, the current price lends a forward P/E of 15, about the same as industry peers. Shares are currently at 19, a decline of 6% since November 2010. By comparison, the S&P 500 returned a positive 3%, including dividends, during the last twelve months.
Disclaimer: This company was selected for review in part because of its performance over the past year. Any outperformance relative to the broader market is not necessarily indicative of performance of the broader Investor Advisory Service.