Initiating coverage: Dr Lal PathLabs (Outperformer) - Right Diagnosis

Dr Lal PathLabs (DLPL) is one of the largest diagnostic chains in India with a pan India presence. 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. DLPL’s strong brand franchise, focus on service & quality and a broad basket of test offerings have enabled the company to create a leading position in North India. The company seeks to replicate this success in East and Central India (commissioning of Kolkata reference lab) and make gradual inroads in the South and West. Focus on volume growth, backed by competitive pricing strategies and steady network expansion underpin our estimate of 16% revenue CAGR and steady ~26% margin over FY18-21E. DLPL has the ability to leverage ~Rs9.6bn cash on books (FY21E) to generate value accretive inorganic growth opportunities. We initiate coverage with an Outperformer rating and a target price of Rs1,184 (35x FY21E EPS).

Volume growth focus takes centre stage: Volume growth considerations now form core of DLPL’s growth plans. Key elements include emphasis on bundled wellness and preventive tests (Swasthfit) to increase samples per patient, maintaining competitive pricing (no major price hikes since 2016) despite a premium brand image in the B2C segment and stepped up aggression in B2B segment. DLPL has enhanced focus on the franchisee route to accelerate its pan-India network expansion. Patient volume growth of 22%yoy in H2FY18 and 18% yoy in Q1FY19, post several muted quarters, adds comfort on effectiveness of this strategy.

Profitability to sustain: DLPL believes brisk volume growth will translate into significant scale benefits and resultant lower sample processing costs. This will aid DLPL’s competitiveness in a price-sensitive market. DLPL’s niche high-end tests menu complements this advantage. The company aims to supplement scale efficiencies through continued multi-pronged cost rationalization initiatives to sustain current ~26% EBITDA margin, despite limited projected price hikes and general cost inflation.

Set to get bigger: With scale-driven efficiencies inherent in diagnostics business, we expect economic gains to increasingly get concentrated with select large players and create multi-year growth stories. We see DLPL as one of the winners, given its proven execution capabilities and profitable business model (FY21E ROIC ~89%). We initiate coverage on the stock with an Outperformer rating. Change in government regulations, mainly price caps, remains a key risk to the business.