Dr Lal PathLabs' Q2FY20 results (Neutral) - Inline quarter; Cost control aidsprofitability

Q2FY20 result highlights

• DLPL reported sales of Rs3.6b (+15% yoy; Q1:Rs3.4b) inline with est led by a 3% yoy realization growth and 10% vol growth
• Realisation/patient (3% growth yoy to Rs684) was partially offset by a lower than expected vol growth (10% yoy vs est 12% growth). Mgt cited a higher contribution from cities outside Delhi-NCR as the primary driver for volume growth. While Delhi-NCR volumes grew 11%, RoI volumes grew 20.2% and accounted for 59% of total volumes (vs 57% last year).
• GMs came in lower at 77.8% (78.8% in Q1) vs our est of 78.8% while SG&A cost stood lower. Reported EBITDA stood at Rs1.1bn. Adj. for Ind AS 116, adj. EBITDA stood at Rs1bn (15% yoy) inline with est with adj. margins of 27.4% (26% in Q1) inline with est.
• Reported PAT stood higher at Rs805m. Adj. PAT at Rs824m (44% yoy) vs our est of Rs770m driven by lower tax rates.
• DLPL aim to maintain the current volume growth momentum and will continue to focus on improving test mix.  No price hikes are planned in the near term. Cost optimisation continues to be a key focus. Continue to explore inorganic growth opportunities.
• Mgt expects RoW volume growth to keep outpacing growth in Delhi-NCR. While this should adversely impact realization / patient (RoW realisation are ~70% of Delhi-NCR), mgt doesn’t see any adverse impact on profitability per se due to lower operating costs in the RoW markets.

Impact on financials: Increase FY20e/FY21e earnings by 21% / 19% to primarily account for lower tax rates.

Valuations & view

While the macro story for the fragmented, yet steadily consolidating Indian diagnostic space remains exciting, increasing competitive intensity along with pricing pressures has impacted the organic profitability growth of even the industry leaders. This is reflected in DLPL’s 12% CAGR EBITDA growth over FY16-19. However, DLPL seems to be effecting a comeback with 16% EBITDA growth in H1FY20 underpinned by a good job on the cost optimisation front. With meaningful price hikes still unlikely in the near term, DLPL’s cost excellence will continue to provide an edge over peers. Mgt’s growing intent to step up M&A activity to support organic growth is another positive. Despite these positives, at current price, valuations are rich and offer limited upsides. Any change in government regulations, mainly price caps, continues to be a potential risk. Maintain Neutral with a price target of Rs1,316 (35x FY21E).