Gradual volume growth, valuations to cap diagnostic majors' returns

Riding on the back of network expansion and steady pricing, organised diagnostic players delivered a 14 per cent sales growth in the June quarter. Strong operating leverage in the business drove a 151 basis points year-on-year (157 basis points on a sequential basis) expansion in margins to 28.7 per cent for the sector.

Easing of pressure from predatory pricing and steady network expansion is boosting growth for diagnostics companies, say Abdulkader Puranwala and Nisha Shetty of ICICI Securities.

Post the June quarter results, some brokerages have upgraded their earnings estimates for the larger players and this has reflected on the stock prices. Barring the Metropolis Healthcare (Metropolis) stock, which has been flat over the past month, most diagnostic majors have delivered returns in the early teens during the period.

While the overall sales growth in the June quarter was about 14 per cent, the outperformer was Vijaya Diagnostic Centre (Vijaya) which posted a revenue growth of just under 20 per cent. The growth for Vijaya was almost entirely led by an uptick in test volumes, the growth in footfall was about 17 per cent. 

Though growth for the sector was boosted by higher test volume and better test mix, some of the growth was also a function of increased contribution from the wellness segment. Sumit Gupta of Centrum Research points out that the wellness segment and bundled packages continued to have strong traction leading to higher realisation across their coverage universe.

A relief for the sector has been the easing of competitive intensity over the last couple of years which had put pressure on pricing. However, with lower competitive pressures, larger players have shifted focus to network expansion and mergers/acquisitions to boost their volumes, highlight most brokerages.

While Dr Lal plans to open 20 hub labs every year to improve its test volume, it also has an option of using its Rs 1,000 crore cash balance to acquire smaller peers. Metropolis is also looking at inorganic opportunities to boost its earnings with its current expansion nearing its end. Post the acquisition of PH Diagnostics last year, Vijaya is also on the lookout for more buys to expand its presence.

Despite these steps, a sharp improvement in volume growth is unlikely. Say analysts led by Alankar Garude of Kotak Institutional Equities, “While we expect the sheer higher quantum of organised competitors to still restrict a significant volume bounce-back, we expect volume growth for Dr Lal and Metropolis Healthcare (Metropolis) to inch up gradually from the current 9-10 per cent Y-o-Y.”

They expect a 13-14 per cent annual sales growth over FY2024-27 for the two companies on the back of improved volumes. The brokerage has a reduced rating on the two companies as volume growth is reflecting on valuation, which is on the higher side.

Brokerages are positive about the prospects for Vijaya. “While opening more hubs and expansion in newer markets (Kolkata and Pune) run the risk of driving down margin, the timely breakeven of new centres and double-digit revenue growth in the core business allay our concerns,” say analysts led by Aashita Jain of the brokerage. Solid cash flows and healthy return on invested capital (RoICs) too lend comfort, they add.