RESEARCH INVESTMENT IDEA 31 MAR 2017 Dr. Lal …bsmedia.business-standard.com/_media/bs/data/market-reports/equity... · RESEARCH INVESTMENT IDEA 31 MAR 2017 Dr. Lal PathLabs

PCG RESEARCH INVESTMENT IDEA 31 MAR 2017

Dr. Lal PathLabs

Private Client Group - PCG RESEARCH P a g e | 1

Industry CMP Recommendation Add on Dips to band Sequential Targets Time Horizon

Healthcare Rs. 960 BUY Rs. 890 - 960 Rs. 1090 - 1235 3-4 Quarters

HDFC Scrip Code DRLALPEQNR

BSE Code 539524

NSE Code LALPATHLAB

Bloomberg DLPL

CMP – 31 Mar 17 Rs 960

Equity Capital (Rs cr) 82.7

Face Value (Rs) 10

Equity O/S (cr) 8.27

Market Cap (Rs cr) 8080

Book Value (Rs) 82

Avg. 52 Week Volumes

118344

52 Week High 1280

52 Week Low 792

Shareholding Pattern (%)

Promoters 58.6

Institutions 36.0

Non Institutions 5.4

PCG Risk Rating* Yellow * Refer Rating explanation

Kushal Rughani [email protected]

Company Background

Dr. Lal Pathlabs (DLP) is a leading player in the fragmented & competitive Indian diagnostics market.

Established in 1949, DLP based company has been able to widen its reach to a pan-India network on the back

of strong brand equity and a scalable hub & spoke model, whereby specimens are collected from multiple

locations within a catchment area or region for shipment to a clinical laboratory for centralized diagnostic

testing. This network boasts of a National Reference Laboratory in Delhi (2010), over 172 clinical laboratories,

1,559 patient service centers and 4,967 pick-up points. The company has 172 labs, most of which are in

Northern Region and It is the highest revenue contributor with 72% contribution.

DLP possesses capabilities to carry out a comprehensive range of ~ 1,110 test panels, organized into ~ 1,934

pathological tests and ~ 1,561 radiology & cardiology tests & services in its quality laboratories which have

been accredited by the College of American Pathologists (CAP) and National Accreditation Board for Testing &

Calibration Laboratories (NABL). Its customer mix of individual patients, hospital tie-ups and other healthcare

providers & corporates enabled DLP to test over ~ 22.2 mn & ~ 26.3 mn samples and ~ 10.1 mn & ~ 12.0

mn patients in 9M FY17 & FY16 respectively. Its centralized information technology platform is the backbone

of its efficient operations as it integrates its network through a common logistics & payments system, thereby

allowing efficient collection of samples & payments and offers convenience to healthcare providers & patients

in locating patient service centers, booking tests and accessing test results online through their website &

mobile app. DLP has established an international presence as well through its partners in the Middle East,

Africa & South East Asia.

Investment Rationale

Diagnostic market size to touch ~US$ 9.8bn by FY18E

Strong brand Dr. Lal PathLabs supported by self-sustaining business model

Has a network of 172 labs, 1500+ PSCs and 4500+ Pick Up Points

Well defined Strategy in place – “Hub and Spoke Model”

Patient Service Centres (PSC) – quickest way forward for expansion

mailto:[email protected]

PCG RESEARCH


Risk & Concerns: aa View & Valuation: Talwalkars Better Value

To set up two more reference Labs at Kolkata and Lucknow

Set to post 20% revenue and 33% PAT cagr over FY16-19E

Strong Free Cash Flows and robust balance sheet

Diagnostic market size to touch ~US$ 9.8bn by FY18E

The size of the diagnostic services market in India is estimated at US$ 6.5bn inFY15 and the industry is likely

to post 17% cagr to touch US$ 9.8bn by FY18E. Moreover almost 82-85% of market remains unorganized

which leaves significant opportunity for the organized players like SRL diagnostics, Dr. Lal PathLabs,

Metropolis etc. DLP has posted 20% revenue and 33% PAT cagr over FY12‐16 with operating margin range of

~23‐27% and robust RoE/RoCE of 30‐35%. We expect ~19% revenue cagr and 21% PAT cagr over FY15‐18E

with 230bps margin expansion. Management is keen on to expand its presence in existing markets such as

North and East. DLP is setting up two more Reference labs in Kolkata and Lucknow. In other geographies,

Company is likely to do network expansion through strategic acquisitions and partnerships. As part of growth

strategy, company also plans to foray into international markets by opening laboratories in neighboring

countries such as Nepal, Bangladesh and Sri Lanka, as well as selective entry into African and Middle East

countries. Currently, International revenues are negligible or to the tune of ~Rs 10cr.

Beneficiary of industry shift

Increasing incomes, medical awareness, emergence of preventive healthcare and only a modest pricing

differential has led to a gradual shift towards regional/national chains that offer a wide range of tests at

attractive rates. Thus, while the industry will grow in the low-teens, we expect the chains to grow in mid-to-

high teens. Company has dominant market share in North market. We believe Dr. Lal’s strong consumer-

brand in its legacy northern market has helped it garner not only market share, but also a premium with

compared to other players.

Unlike pharma companies, which face several headwinds such as regulatory interference and pipeline

pressures, the organised diagnostic industry has limited competition, which should ensure sustainable

volume-driven growth. We expect the Return Ratios to be in the range of 25–30%. We believe these factors

should help Dr. Lal Path sustain its premium valuations. The company has Rs 370cr as cash and current

investments in the balance sheet as on Dec 2016. These are adequate to fund future growth as company is

setting up two additional Reference Labs (Rs 100-110cr) and satellite labs (each lab cost: Rs 3–4cr).

PCG RESEARCH


Strong brand supported by self-sustaining business model

DLP has established itself as a strong brand in the pathology diagnostics market, especially in North India,

which contributes ~70% of the company’s revenues. The hub-and-spoke model has provided the company a

strong competitive advantage versus standalone chains and has helped the company in establishing a strong

foothold in North India around its National Reference Lab. We like DLP’s strategy (1) expansion in a fast-

growing market through well-established hub-and-spoke model, (2) strong franchise network, (3) tapping

new market opportunities such as South and East, all of which are underpinned by a wide array of test menu

and backed by a strong management team and logistics system.

Massive untapped market

The Indian diagnostic market, which is growing at 15–16% per annum, is the result of increasing healthcare

penetration in India as well as a surge in non-communicable disease. This combined with increasing spend on

healthcare has led to a double-digit growth across the healthcare space—pharma, diagnostics and healthcare

services such as hospitals. The national chains such as Dr. Lal Path, SRL and Metropolis form miniscule 6–8%

of the Rs 380bn diagnostic market.

Well-defined strategy in place; Hub-and-spoke model

Dr. Lal has a well-defined strategy, which can fuel sustainable growth, going forward. The hub-and-spoke

model ensures that high-capex incurring reference labs are fewer in number and expansion is mainly through

clinical labs, patient service centres (PSC) and pick up points (PUPs).

This includes the National Reference Laboratory in New Delhi, 172 other clinical laboratories (of which 166

are owned), 1,559 PSCs and almost 5,000 PUPs. The specimens are collected across multiple locations within

a region for delivery to a clinical laboratory for centralised diagnostic testing; this not only provides for

greater economies of scale, but also offers a scalable platform for the continued growth of the business.

A regional reference lab is located in or around a metropolitan city. It accumulates samples from satellite

labs and PSCs across the region. Usually these are equipped to do a variety of tests ranging from the most

basic to the specialised ones including radiology. The newly opened labs generally get break-even within 4-5

quarters from commencement of operation. They perform basic testing functions through the samples it

generates as well as those acquired from PSCs. The more complex tests are referred to the regional

reference/national reference labs.

Collection centres are an effective way to enhance the sample collection. They are located in nursing homes,

hospitals, pathology labs, doctors’ clinics and also on rented premises. They are either company-owned or

franchised, in which case company pays as franchisee fee to get the license to operate a collection centre for

a satellite lab.

PCG RESEARCH


DLP is setting up another two reference Labs at Kolkata and Lucknow

Dr. Lal PathLabs has been granted land in New Town, Kolkata, covering an area of approximately 1,500

square meters, by the West Bengal Housing Infrastructure Development Corporation Limited, for construction

of regional reference laboratory in Kolkata. The majority of clinical laboratories and other business premises,

including patient service centers and local corporate offices, are leased. Typically, the leases range from five

to seven years.

With an aim to ramp up its capabilities in routine & specialized tests in its core markets similar to its Delhi

clinical facilities, the company has decided to construct a 50,000 square feet regional reference lab in

Kolkata. This lab is expected to be commissioned by Sep 2017 at a capex of ~Rs 50cr. One more such lab is

expected to come up by H2 FY19 in Lucknow. Thus, these two labs would enhance DLPs revenues

substantially in the coming years. This would have twin benefits of raising DLPs brand equity in a big way

and de risking its business with reduced dependency on its New Delhi facilities for specialized testing.

PSC – quickest way forward for expansion

Dr. Lal has swiftly expanded its Patient Service Centre (PSC) network from 824 in FY13 to 1,559 in FY16, of

which 1,475 are exclusive franchisees. Management has indicated that the trend to expand through PSCs is

likely to continue in the coming years as well. This enables the company to: a) expand geographically with

minimum capital pressure and also increase brand awareness; b) raise volumes that will boost asset

utilisation, and c) increase volumes, which will lead to better bargaining power with suppliers and thus lower

input cost. DLP provides technical, personnel and marketing support to these franchisees and also requisite

consumables and collection materials. The agreement ranges from a period of five to nine years and it

operates under a revenue sharing model.

Premium valuations justified given strong growth; Recommend BUY with TP of Rs 1235

We initiate on Dr. Lal PathLabs with a BUY recommendation with a target price of Rs 1,235. The company is

one of the key players in the organised space of a highly fragmented market. We see DLP to be key

beneficiary on the shift toward the organised space. While other players Thyrocare, Metropolis and SRL—will

provide stiff competition, an expanding geographic footprint should ensure that growth rates remain

unaffected as Dr. Lal’s brand building starts to deliver in the form of higher business from standalone

centres. Furthermore, the hub-and-spoke business model ensures a low capital outlay and quick initiation of

labs.

Dr. Lal PathLabs has posted 21% revenue and 30% PAT cagr over FY13‐16 and we expect the momentum to

continue over the next 2‐3 years. We forecast 21% revenue cagr over FY16-19E led by growth from across

the board all the geographies. We expect smaller geographies like West and South to exhibit faster growth

given the smaller base. As per management commentary, we believe that company would maintain margins

25-26% in the next 2-3 years.

PCG RESEARCH


Margins would remain compressed given company is opening newer labs, rationalising its PUPs and to open

another two reference labs. We foresee company to post 21% PAT cagr over the same period. Company has

172 labs as Mar2016.We expect company to add 35-40 labs over FY16‐19E with nominal rise in revenue per

laboratory. We build in 19% revenue and 21% PAT cagr over FY15‐18E with ~230bps margin expansion. We

like the underlying business on the back of robust growth in revenues/PAT over past 4‐5 years along with

sustained revenue visibility. Dr. Lal PathLabs has corrected ~28% from its peak of Rs 1280 and now it is

trading at attractive 33x FY19E earnings and 20x EV/EBITDA. We believe that DLP’s long term growth

potential remain intact given superior Brand equity and execution track record. A strong brand franchisee,

stellar return ratios in the range of 30-35%, robust balance sheet and free cash flows justify premium

valuations. The company’s secular growth story and superior return metrics make a compelling long-term

story. We recommend investors to BUY Dr. Lal PathLabs in the range between Rs 890 to 960 with sequential

targets of Rs 1090 and Rs 1235 over the next 4 quarters.

Risks and Concerns

The performance, growth & integrity of the Dr. Lal Pathlabs brand name relies on the performance of

franchisees which control more than 90% of the 1,559 centers as on FY16. Any major allegations

related to Tests / Quality can be severely damaging to the brand equity of DLP which functions in a

competitive B2C market where quality & trust play a major role.

Competitive pressures from both unorganized players which form ~ 85% of market as well as rise of

more regional & pan-India chains can lead to undercutting of prices, suppressing margins.

While the diagnostic healthcare services industry in India is presently not subject to extensive

governmental control, the government could introduce more stringent regulations. Any changes in

regulations or introduction of price controls for the larger benefit of society could have a material

adverse effect on DLPs business, operating revenues & cash flows.

Any interruptions in DLPs Delhi national reference laboratory or its information technology systems

which form the backbone of its entire business model could lead to serious disruptions in operations &

profitability.

Technology adaptation has been one of the strengths and Company has successfully rolled out new

tests on contemporary technology platforms in the past. With continuous availability of new

technologies, DLP needs to remain competitive by ensuring swift adoption of such new technologies

with focus on benefits and returns.

PCG RESEARCH


Financial Summary

(Rs Cr) FY14 FY15 FY16 FY17E FY18E FY19E

Sales 558 660 791 927 1144 1393

EBITDA 138 157 209 246 294 361

Net Profit 80 95 133 163 197 239

EPS (Rs) 9.6 11.6 16.1 19.8 23.8 28.9

P/E 97.1 80.4 58.1 47.3 39.3 32.3

EV/EBITDA 54.4 47.8 35.9 30.5 25.5 20.8

RoE 40.1 32.8 31.2 27.6 26.3 26.3 Source: Company, HDFC sec Research

Comparison with Other Diagnostic Players

Diagnostic Chain Presence Accrediations Laboratories Market Cap (Rs cr)

Dr. Lal PathLabs India, Middle East, Nepal, Malaysia NABL, ISO,CAP,CDC (USA) 172 7985

SRL Diagnostics India, Middle East, Nepal, Africa and Maldives NABL, ISO,ICAL, CLIA,APLAC 265 NA

Thyrocare* India, Nepal, Bangladesh and Gulf countries ISO,CAP, NAGL 1 3850

Metropolis India, UAE, Sri Lanka, South Africa NABL, ISO,CAP, CLIA (USA) 150 NA

Source: Company, HDFC sec Research, NA – not listed on Exchanges, * Operates through centralized Lab at Navi Mumbai

PCG RESEARCH


Revenues to post 21% cagr over FY16-19E

558660

791

927

1144

1393

0

300

600

900

1200

1500

FY14 FY15 FY16 FY17E FY18E FY19E

Rs

Cr

Source: Company, HDFC sec Research

EBITDA and PAT trend over FY14-19E

138157

209

246

294

361

8095

133163

197

239

0

50

100

150

200

250

300

350

400


EBITDA PAT


Robust Return Ratios (%)

40.1

32.8 31.227.6 26.3 26.3

52.5

42.8 41.2

35.9 34.0 34.6

0.0

10.0

20.0

30.0

40.0

50.0

60.0


RoE RoCE


Laboratory Count

131

146

164172

0

20

40

60

80

100

120

140

160

180

200

FY13 FY14 FY15 FY16

#


PCG RESEARCH


PSC addition trend over FY13-16

824

1064

1340

1559

0

200

400

600

800

1000

1200

1400

1600

1800

FY13 FY14 FY15 FY16

#


FY19E Revenue Split (%)

70

8

9

13

North South West East


Northern Region revenue trend

409476

570657

804

959

0

200

400

600

800

1000

1200


Rs

Cr


Revenues trend for Western Region

4757 55

71

92

127

0

20

40

60

80

100

120

140


Rs

Cr


PCG RESEARCH


Three Different Models

Hospital Based Centres

Diagnostic Centres located within Hospitals. Mostly owned by Hospitals and also given third parties to manage the same.

Diagnostic Chains

Privately Owned Diagnostic Centres with two or more centres. Operates through Hub and Spoke Model of Collection Centres

Standalone Centres

Single Diagnostic Centre. Majority has small scale of operation and offer basic diagnostic tests


Segment wise Diagnostic centres breakup (%)

48

37

15

Standalone Hospital Based Diagnostic Chains


Projected Growth of Indian Diagnostic Industry

37.7

60.5

10

20

30

40

50

60

70

FY14-15 FY17-18P

Rs . '000cr


PCG RESEARCH


Income Statement

(Rs Cr) FY15 FY16 FY17E FY18E FY19E

Net Revenue 660 791 927 1144 1393

Growth (%) 18.3 19.8 17.2 23.3 21.8

Operating Expenses 503 582 681 849 1032

EBITDA 157 209 246 294 361

Growth (%) 13.8 33.1 17.8 19.6 22.6

EBITDA Margin (%) 23.8 26.4 26.5 25.7 25.9

Depreciation 28 28 28 35 40

EBIT 129 181 218 259 321

Other Income 11 20 25 29 32

Interest 0 1 1 1 1

PBT 140 201 240 289 352

Tax 45 68 77 93 113

RPAT 95 133 163 197 239

Growth (%) 18.8 40.6 22.8 20.3 21.8

EPS 11.6 16.1 19.8 23.8 28.9


Balance Sheet


SOURCE OF FUNDS

Share Capital 81.3 82.7 82.7 82.7 82.7

Reserves 260 424 589 734 913

Shareholders' Funds 343 510 674 819 997

Long term Debt 0 0 0 0 0

Net Deferred Taxes -25 -12 -18 -18 -18

Long Term Provisions & Others 0 0 0 0 0

Total Source of Funds 332 513 681 823 1018

APPLICATION OF FUNDS

Net Block 92 112 165 195 218

Intangibles 18 16 19 19 19

Goodwill 42 42 54 54 54

Long Term Loans & Advances 17 20 25 32 40

Total Non Current Assets 169 190 263 300 331

Inventories 14 15 20 31 34

Trade Receivables 31 36 48 56 69

Cash & Equivalents 148 230 270 352 451

Other Current Assets (incl Curr Invests) 89 143 184 235 325

Total Current Assets 282 424 522 674 879

Trade Payables 41 52 67 88 112

Other Current Liab & Provisions 78 49 44 55 59

Total Current Liabilities 119 101 111 144 171

Net Current Assets 163 323 411 531 709

Total Application of Funds 332 513 681 823 1018 Source: Company, HDFC sec Research

PCG RESEARCH


Cash Flow Statement (mn)


Reported PBT 140 201 240 289 352

Non-operating & EO items -11 -20 -25 -29 -32

Interest Expenses 0 1 1 1 1

Depreciation 28 28 28 35 40

Working Capital Change -57 -65 -54 -30 -75

Tax Paid -45 -68 -77 -93 -113

OPERATING CASH FLOW ( a )

55 77 113 175 173

Capex -67 -35 -65 -60 -35

Free Cash Flow -12 42 48 115 138

Investments 0 0 0 0 0

Non-operating income 11 20 25 29 32

INVESTING CASH FLOW ( b ) -56 -15 -40 -31 -3

Debt Issuance / (Repaid) 0 0 0 0 0

Interest Expenses 0 -1 -1 -1 -1

FCFE -13 41 48 114 137

Share Capital Issuance 1 1 0 0 0

Dividend -12 -23 -33 -52 -66

FINANCING CASH FLOW ( c ) -11 -22 -33 -53 -67

NET CASH FLOW (a+b+c) -13 39 40 90 103 Source: Company, HDFC sec Research

Key Ratios

Key Ratios (%) FY15 FY16 FY17E FY18E FY19E

EBITDA Margin 23.8 26.4 26.5 25.7 25.9

EBIT Margin 19.5 22.9 23.5 22.7 23.1

APAT Margin 14.3 16.8 17.6 17.2 17.2

RoE 32.8 31.2 27.6 26.3 26.4

RoCE 42.8 41.2 35.9 34.0 34.6

Solvency Ratio

Net Debt/EBITDA (x) -1.2 -1.4 -1.5 -1.7 -1.9

Net D/E -0.5 -0.6 -0.5 -0.6 -0.7

Interest Coverage 392.5 418.0 492.3 294.4 360.8

PER SHARE DATA

EPS 11.6 16.1 19.8 23.8 28.9

CEPS 15.1 19.5 23.2 28.0 33.7

BV 41.5 61.6 81.5 99.0 120.6

Dividend 1.3 2.5 3.5 5.5 7.0

VALUATION

P/E 82.5 59.7 48.6 40.4 33.2

P/BV 23.1 15.6 11.8 9.7 8.0

EV/EBITDA 49.1 36.9 31.3 26.2 21.4

EV / Revenues 11.7 9.7 8.3 6.7 5.5

Dividend Yield (%) 0.1 0.3 0.4 0.6 0.7

Div Payout 11.2 15.2 17.7 23.1 24.2 Source: Company, HDFC sec Research

PCG RESEARCH


Rating Chart

R E T U R N

HIGH

MEDIUM

LOW

LOW MEDIUM HIGH

RISK

Ratings Explanation:

RATING Risk - Return BEAR CASE BASE CASE BULL CASE

BLUE LOW RISK - LOW RETURN STOCKS

IF RISKS MANIFEST PRICE CAN FALL 20% OR MORE

IF RISKS MANIFEST PRICE CAN FALL 15%

& IF INVESTMENT RATIONALE

FRUCTFIES PRICE CAN RISE BY 15%

IF INVESTMENT RATIONALE

FRUCTFIES PRICE CAN RISE BY 20% OR

MORE

YELLOW MEDIUM RISK - HIGH RETURN STOCKS






FRUCTFIES PRICE CAN RISE BY 35% OR

MORE

RED HIGH RISK - HIGH RETURN STOCKS







OR MORE

PCG RESEARCH


Price Movement

100

300

500

700

900

1100

1300

1500

Rating Definition:

Buy: Stock is expected to gain by 10% or more in the next 1 Year. Sell: Stock is expected to decline by 10% or more in the next 1 Year.

PCG RESEARCH


I, Kushal Rughani, MBA, author and the name subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. Further Research Analyst or his relative or HDFC Securities Ltd. or its associate does not have any material conflict of interest. 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RESEARCH INVESTMENT IDEA 31 MAR 2017 Dr. Lal …bsmedia.business-standard.com/_media/bs/data/market-reports/equity... · RESEARCH INVESTMENT IDEA 31 MAR 2017 Dr. Lal PathLabs