Dr Lal PathLabs' Q3FY20 results (Downgrade to Underperformer) - Inline quarter; expensive valuation

Q3FY20 result highlights

• DLPL reported sales of Rs3.3b (+12% yoy; Q2:Rs3.7b) inline with est led by a 12% vol growth and flat realization growth
• Realisation/patient grew 0.7% yoy to Rs688 (est Rs690) while patient volume growth was 12% vs est 11%.  Mgt cited a higher contribution from cities outside Delhi-NCR as the primary driver for volume growth. While Delhi-NCR growth softened sharply to 2%, RoI volumes grew 19.8% and accounted for 61.2% of total volumes (vs 59% in Q2). Mgt attributed harsh Delhi winters as a primary driver for slow growth.
• GMs came in lower at 77.3% (77.8% in Q2) vs est of 77.7% while other exp stood lower. Reported EBITDA stood at Rs823m. Adj. for Ind AS 116, adj. EBITDA stood at Rs735m (12% yoy) inline with est with adj. margins of 22.4% (27.4% in Q2) above est of 22.2%.
• Reported PAT Rs549m. Adj. PAT at Rs567m (23% yoy) vs est Rs578m
• DLPL aims to maintain the current volume growth momentum and will continue to focus on improving test mix. Mgt expects RoW volume growth to keep outpacing growth in Delhi-NCR (growth in the core region likely capped at ~8%).
• No price hikes are planned in the near term. Cost optimisation continues to be a key focus. Continue to explore inorganic growth opportunities.

Impact on financials: Decrease FY20E/FY21E earnings by 4%.

Valuations & view

While the macro story for Indian diagnostic space remains exciting, high competitive intensity along with pricing pressures has impacted the profitability growth of even the industry leaders. This is reflected in DLPL’s 12% CAGR EBITDA growth over FY16-19 and 15% growth in 9MFY20, underpinned by a good job on the cost optimisation front. With meaningful price hikes unlikely in the near term, DLPL’s cost excellence will continue to provide an edge over peers. However, emerging growth challenges in high margin NCR market will constrain profitability growth and we estimate 16% EBITDA CAGR growth over FY19-22E assuming continued stellar job on cost optimization. While we like DLPL’s business model, post the sharp run-up in recent months, valuations are now fairly rich at 41.4x FY22E PER with limited upside risks on profitability growth and declining RoE. Hospital peers offer similar EBITDA growth outlook at significantly better valuations. Additionally, potential entry of disruptors like Jio and price regulations continue to be risks.  Downgrade to Underperformer with a price target of Rs1,658 (40x FY22E PER / 27.6x EV/EBITDA (FY22E)).