No rerating yet for diagnostic players despite price hikes as margins fall

While discounts have come down, pricing gap still large between incumbents and new players

After December quarter results, which were a mixed bag, and muted near term outlook of listed diagnostics players, brokerages have cut their estimates for FY24. They expect volumes and realisations to be under pressure given weakness in Covid-adjusted test volumes and higher competitive pressures.

In a post Q3 results note on Dr Lal, Bhavesh Gandhi of YES Securities pointed out that there has been a lack of volume revival in recent quarters with an increasing likelihood that FY24 too, would be a work-in-progress year for the company’s initiatives to bear fruit. They have reduced volume growth to mid-single digits next fiscal from an earlier forecast of 10-11 per cent, which basically postpones recovery by a year. While keeping estimates for this year at earlier levels, the brokerage has cut earnings estimates by 20 per cent for FY24.

While Nuvama Research is confident of a decent rise in patient visits and test samples at Metropolis driven by network expansion and the addition of laboratories, it is cautious about the sustenance of realisation per patient given the fierce competition in the market. What has changed, however, is the increase in prices by incumbent diagnostic majors and expectations of lower competitive intensity going ahead as online preventive packages too, have seen a price increase of 6-8 per cent.

While competitive pressure persists in the business to business segment, it has come down a bit in the retail segment. Dr Lal PathLabs has raised prices of some of the semi-specialised diagnostics tests such as HIV, Vitamin B12, Vivax and Falciparum among others by about 8-12 per cent. High-end tests like genetics, biomarkers where Dr Lal has an edge could see a similar increase and the full impact will be reflected in the first half of FY24. Metropolis, too, is considering hiking prices in the specialised segment where competitive pressures are lower.

Despite the hikes, brokerages do not believe this will lead to a rerating. Analysts led by Prakash Agrawal of Axis Capital say that price-to-earning derating is likely to persist in the diagnostic segment as two factors continue to pressure valuations. These are sliding margins from 27 per cent in FY22 to 24 per cent in FY25 (9MFY23 at 24.8 per cent) on weaker pricing power/ increasing online competition and costs and falling return on equity following expensive mergers and acquisitions. Kunal Randeria and Aashita Jain of Nuvama Research have a similar view.

Despite diagnostic pricing moving north, 70 per cent price difference restricts incumbents' ability to take consistent price hikes, thus limiting rerating potential. Likewise, hardening pharmacy discounts is unlikely to throw margin surprises, they add. The stocks are reflecting the pricing and volume pressures in the market with Dr Lal shedding 23 per cent over the past three months while Metropolis is down 7 per cent over this period. At the current price, Dr Lal is trading at 43.7 times its FY25 earnings while Metropolis is available at 25 times.