Diagnostic players ride on changes in health insurance to beat slowdown

Metropolis, Dr Lal and Thyrocare are likely to see more gains led by expansion, increasing penetration, preventive testing and government's Ayushman Bharat scheme

Diagnostic players such as Metropolis and Dr Lal Pathlabs have been significant outperformers on the bourses. Their share prices are up over 30 per cent since May lows and are presently not far from their 52-week highs seen last month. While the broader indices have remained volatile during this period amid slowdown concerns, these pathology laboratory players have been able to attract investor attention. Given the robust business growth outlook, there seem to be more gains ahead. These companies would also gain from lower corporation tax rates, given their FY19 effective tax rate of 33-38 per cent. Analysts at Kotak Institutional Equities have raised their estimates for diagnostics companies such as these by 13-14 per cent over FY20-22.

Analysts say that organised players have just been scratching the surface, while there is ample scope for growth in this underpenetrated and growing industry. The increased inclusion of diagnostic testing in health insurance, increasing preventive healthcare testing, and the government’s Ayushman Bharat scheme all remain key growth drivers. 

While concerns over potential price caps by the government on essential tests remain, analysts feel that higher penetration and a wide range of tests can help counter such moves. Experts say that the regulations and standards of testing are necessary in an industry having a large number of unorganised players before any price cap is set. For large pathology chains, the customers’ confidence on the quality of testing, standards, and procedures is driving growth. Analysts at Ambit Capital a­dd that price caps won’t be draconian, gi­v­en implementation challenges. More­o­ver, pricing pressures could be offset through itemised pricing and volume gains from unorganised players. 

Large pathology players such as Metropolis, Dr Lal and Thyrocare are also better placed on the profitability front, given their ability to negotiate better rates on their reagent rentals.

Metropolis Healthcare, the top performing stock on the bourses, has a strong presence in the West and is expanding to the South. Analysts say that the firm is creating leadership in the West like Dr Lal Pathlabs has done in the north through a wider range of tests and deeper penetration. Recently, the company completed new acquisitions of a few pathology labs in Gujarat. Increasing B2C (direct to customer) revenue share also bodes well, and this itself is likely to drive 21 per cent annual growth in profits over FY19-22, estimate analysts at Ambit. 

Kotak Institutional Equities is confident of Metropolis’ B2C segment growth, driving profits higher by 20 per cent annually over the same period. The aggressive approach towards buying smaller assets and good earnings visibility from National Aids Control Organisation contracts (HIV testing on specimens from government-owned antiretroviral therapy centres) are other positives. 

Dr Lal Pathlabs continues to focus on volume growth and geographical expansion through both organic as well as acquisitions (Recently, they acquired the Indore-based Central Lab and Amins Pathology in Gujarat). The company has been de-risking from the competitive Delhi-National Capital Region (now 43 per cent of its business), by focusing on East and Central India. Its East India foray through Kolkata Reference Lab now supports a variety of tests, and is the main centre for diagnostics in the region. 

The visibility from Kolkata Lab, Dr Lal’s scale advantage, and the opportunity to grow in preventive testing is leading analysts to remain positive. Analysts at Edelweiss had maintained their positive rating looking at its low-capex, high-capital-efficiency business model (closer to domestic pharma and FMCG companies), and strong brand equity in an underpenetrated domestic market with high growth momentum.

However, given the Street’s high expectations, it is imperative that Dr Lal and Metropolis don’t disappoint on the growth front. Analysts at Kotak Institutional Equ­ities expect both companies to grow faster than the industry rate of 11-12 per cent. 

Their reverse discounted cash flow (DCF) valuation exercise suggests the stocks are factoring in 16.5 - 17 per cent annual growth over the coming years.

Meanwhile, Thyrocare Technologies has underperformed its other two peers on the bourses. Analysts say that it had focused on being the lowest-priced player, while the company’s B2B (business-to-business) model has also kept its growth under check. However, Thyrocare has hiked the price for its sick care business in the B2B segment by 10 per cent, while prices of a few tests in preventive care reduced marginally in the June 2019 quarter. The management has said that the benefits on volumes from price rationalisation in Aarogyam tests will be visible in FY20, and analysts at Prabhudas Lilladher expect at least 15 per cent year-on-year growth in revenues and profits during this period. A few days back, Goldman Sachs had said that increasing volume share in preventive care, broadening B2B network and stabilisation of margins will lead to high teen growth in earnings.