Credit Suisse Initiates Coverage With 'Underperform' On Dr. Lal Pathlabs, Metropolis Healthcare

The Indian diagnostics industry is facing heightened competition, the Credit Suisse report said.

<div class="paragraphs"><p>(Source: Unsplash)</p></div>
(Source: Unsplash)

Credit Suisse has initiated coverage on diagnostic service providers Dr. Lal Pathlabs Ltd. and Metropolis Healthcare Ltd. with an "underperform" rating, as it sees "high competition" in the space.

The current market prices of Dr. Lal Pathlabs and Metropolis Healthcare still factor in sustenance of high growth levels from the pre-Covid period over the longer horizon (next 15-20 years), the research firm said in its sectoral outlook report released on Sept. 12.

It has cut target price of Dr. Lal Pathlabs to Rs 1,400, indicating a 45% downside, and has set a target price of Rs 1,165 per share for Metropolis.

"The diagnostic firms trade at a premium to India pharmaceutical players despite lower entry barriers and lesser moat in the business. Despite significant correction in diagnostic stocks, we expect further bridging of the valuation mismatch going ahead," the report said.

According to the report, the competitive intensity could lead to return on capital employed for the players to settle in the range of ~20-25% by FY27E, implying an Ebitda margin of ~20%.

Large conglomerates (Reliance Industries Ltd.-Netmeds, Tata 1mg, etc.) and pharma groups (Lupin Ltd., Torrent Pharmaceuticals Ltd., etc.) are likely to pour in larger investments for a longer period, it said.

Key Highlights:

  • The Indian diagnostics industry is facing heightened competition.

  • Competition is especially affecting the high margin routine and wellness test segment in metro cities, which continues to constitute the bulk of incumbents’ profits.

  • The competition is mainly from integrated horizontal players that have better ability to offer more services and spend on customer acquisition.

  • The industry has high RoCE currently (40-50% post-tax, ex-cash) and low entry barriers due to limited capital requirement.

  • Ebitda margin of Dr. Lal Pathlabs and Metropolis has already declined by 300 basis points (vs pre-Covid) to ~23% (pre-Ind AS 116 accounting standards). It expects it to steadily contract by a further 300-400 basis points.

  • Ebitda margin outlook could be further impacted as firms spend more on customer acquisition, network expansion, digitalisation, and rationalisation of prices of non-specialised tests.

  • Also, there is additional risk of higher payout structure to franchises, which poses further downside risk to margins.

  • Net impact on margins would continue to be negative in the near term.

  • Network expansion is increasing competition among existing participants. For example- Dr. Lal Pathlabs entering west and south India, which are Metropolis' key markets.

  • There are concerns that the impact from competition would be felt earlier, while the benefit from network expansion and the shift from unorganised to organised sector in the market would play out over a longer horizon.

    Key risks to downside:

    Slower ramp-up of digital health platforms and effective retention of patients via loyalty programmes.