Event update: Dr Lal PathLabs (Neutral) - Gradually stepping up inorganic growth initiatives

Event

DLPL has acquired 70% equity stake in a couple of Indore labs

Key highlights

• DLPL has acquired a majority stake in a company comprising of two Indore based labs owned by Vinita Kothari and Sushila Dalal for a consideration of < Rs~0.5bn (FY19 rev – Rs135mn). This deal strengthens its presence in Madhya Pradesh – relatively untapped market.
• Earlier in April, DLPL had also acquired a pathology lab (Bawankar Pathology) in Bhandara, Maharashtra for Rs50mn on a slump sale basis. (FY18 rev – Rs15mn)
• At a broader level, these transactions will DLPL to enhance its footprint across Central and Western India.
• Although these two deals are not material with respect to the overall financials, they are important because they potentially signal DLPL’s management’s willingness to finally utilize its ~Rs7bn cash pile to step on its inorganic growth initiatives. This will be key to making inroads in markets where DLPL doesn’t have meaningful presence currently.
• We believe inorganic growth is an increasing imperative for the Indian organized diagnostic players to drive accelerated revenue growth / sustain premium valuation multiples especially given signs of slowdown of organic growth trajectory in recent quarters.
• DLPL’s inorganic growth initiatives have lagged peers like Metropolis and therefore we view these recent deals, albeit minor, positively.

Valuations & view

The fragmented but steadily consolidating Indian diagnostics industry is estimated to post 14-16% CAGR over FY18-20E implying significant opportunities for stronger organised players like DLPL. While the macro story for the diagnostic space remains exciting, increasing competitive intensity along with pricing pressures is beginning to burden the organic profitability growth even of industry leaders. This is reflected in DLPL’s 12% CAGR EBITDA growth over FY16-19. With meaningful price hikes are still unlikely in the near term, DLPL’s future profitability growth is likely to stay muted with any change in government regulations, mainly price caps, continuing to be a potential risk. Post the recent uptick, valuations are rich and offer limited upside from current levels. Maintain Neutral with a price target of Rs1104 (35x FY21e). DLPL’s ability to further leverage ~Rs9.6bn cash on books (FY21E) through value accretive M&A activity remains a potential upside trigger.