Dr Lal PathLabs Ltd. IPO Note. Our View: Subscribe. Sector: Healthcare

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1 IPO Note (Wholly owned subsidiary of Bank of Baroda) Subscribe Dr Lal PathLabs Ltd. Our View: The company is a provider of diagnostic and related healthcare tests and services in India. Through the company s integrated, nationwide network, the company offer patients and healthcare providers a broad range of diagnostic and related healthcare tests and services for use in core testing, patient diagnosis and the prevention, monitoring and treatment of disease and other health conditions. Company s customers include individual patients, hospitals and other healthcare providers and corporate customers. In Fiscal Year 2015, the company collected and processed approximately 21.8 million samples from approximately 9.9 million patients. The company s revenue has grown at a CAGR of 29% for the period FY In the spectrum of healthcare delivery services in India, diagnostic services play the role of an information intermediary, providing useful information for correct diagnosis and treatment of patients diseases. Diagnostic services would have a lower share in overall healthcare spends, yet play a vital role in identifying problem areas and major illnesses. Company s major competitors are SRL Diagnostics, Metroplois, etc. The company has added 18 Clinical Laboratories, 14 Owned Patient Services Centre, 262 Franchisee Patient Services Centre and 1,442 Pickup Points in FY The company has posted a revenue of Rs. 6.60bn / 5.58bn in FY15 / FY14. The company has got a healthy EBITA margins of 23.98% / 25.13% in FY15 / FY14. The company follows an asset light model because of which the company does not have any Long and Short Term borrowings. This leaves a lot of room for the Company to leverage its Balance Sheet at a further date for aggressive expansion, if it chooses to do so. Further, the Company has got a robust ROE of 27.63% / 34.38% for FY15 / FY14. We recommend SUBSCRIBE to our investors as the company s past track record is very impressive and others cannot replicate the Company s size and scale in the short term. Further, this is the first company to be listed from the diagnostic segment which has a lot of growth potential to grow in the medium to long term time horizon. Utilization of net proceeds of the offer: The company is not issuing any fresh equity shares which are being offered to the public. Existing investors are offering their equity shares in the company s IPO. Sector: Healthcare 4 th December, 2015 Issue Highlights Issue Period Price Band 8th Dec- 10th Dec Rs Issue Size No. of shares offered (MN) Rs.6300 MN 11.6 No. of Shares Post Issue in MN 82.6 Distribution of shares Shares (Mn) Shares (%) QIB Category Non- Institutional Category Retail Category Face Value Minimum Order Quantity Rs shares Listing BSE & NSE Book Running Lead Manager Kotak Mahindra Capital Co., Citigroup global Markets India Pvt Ltd. Registrar to the Offer Link Intime Pvt Ltd Exhibit 1: Details of shares offered by the existing shareholders along with their holding pre and post IPO Name of the shareholder Pre IPO Holding Shares offered in IPO Post IPO Holding Brig. Dr. Arvind Lal 282,34,880 12,61, ,72,884 Dr. Vandana Lal 179,88,640 20,56, ,31,893 Eskay House (HUF) 19,20,000 2,38,226 16,81,774 Mr. Anjaneya Lal 22,40,000 5,50,386 16,89,614 Wagner Ltd 58,60,800 58,60, WestBridge Crossover Fund, LLC 14,72,375 14,71, Sanjeevini Investment Holdings 1,61,070 1,61,070 - Source: Company's RHP, BOBCAPS Vishal Dalmia vishal@bobcaps.in Hareesha Kakkera hareesha@bobcaps.in

2 Business Overview With over 3,368 diagnostic and related healthcare tests and services offered, the company believes that it is capable of performing substantially all of the diagnostic healthcare tests and services currently prescribed by physicians in India. Company s diagnostic and related healthcare tests and services include (i) routine clinical laboratory tests such as blood chemistry analyses and blood cell counts; (ii) specialized testing services such as histopathology analyses, genetic marker-based tests, viral and bacterial cultures and infectious disease tests; and (iii) preventive testing services such as screenings for hypertension, heart disease and diabetes. Through the nationwide network, company offer a range of approximately 1,079 test panels, which are organized into approximately 1,813 pathological tests and 1,555 radiology and cardiology tests, as well as services that cover a range of specialties and disciplines. Healthcare Market in India Structure of healthcare market in India The healthcare market in India broadly comprises the following: Healthcare delivery market (hospitals) as per CRISIL Research estimates, the Indian healthcare delivery market stands at Rs. 3,800 billion as of Pharmaceutical industry as per CRISIL Research s estimates, the Indian pharmaceutical market, which comprises the domestic demand for formulations, stands at Rs. 746 billion as of Diagnostics industry as per CRISIL Research s estimates, the Indian diagnostics industry currently stands at Rs. 377 billion as of Healthcare insurance industry The health insurance premium market stands at Rs. 175 billion as of , based on the report of the Insurance Regulatory and Development Authority ( IRDA ). Exhibit 2: Healthcare market in India Healthcare market in India Healthcare Delivery (Hospitals) Diagnostics Industry Health Insurance Medical Equipments Pharmaceuticals Industry Since there exists a certain degree of overlap in terms of function as well as revenues among the segments, the same cannot be consolidated to arrive at the market size of the Indian healthcare market. Healthcare spends in India stand at a low 4% of GDP According to the Global Health Expenditure Database compiled by the World Health Organization ( WHO ), India s total expenditure on healthcare was 4% of India s gross domestic product ( GDP ) as of India trails not just developed countries such as the United States and the United Kingdom, but also developing countries, such as Brazil, Russia, China and Thailand, in healthcare spending as a proportion of GDP. This is primarily due to the under penetration of healthcare services and lower consumer spending on healthcare. Equity research 2

3 Exhibit 3: Total healthcare expenditure as % of GDP (2013) 18.0% 15.0% 12.0% 9.0% 6.0% 3.0% 0.0% 17.1% United States of America 9.7% 9.1% 6.6% 6.0% 5.6% Brazil United Kingdom Russian Federation Vietnam China 4.6% 4.0% 4.0% 3.1% Thailand India Malaysia Indonesia India s per capita total expenditure on healthcare (at the international dollar rate, adjusted for purchasing power parity) was US$ 215 in 2013, versus US$ 9,146 for the United States, US$ 3,311 for the United Kingdom and US$ 1,454 for Brazil. Private expenditure sector accounts for bulk of healthcare spend In 2000, government expenditure accounted for around 27% of the total healthcare expenditure in India, which increased by 5.2% to 32.2% as of The private expenditure refers to expenditure from resources with no government control, such as voluntary health insurance, and the direct payments for health by corporations (profit, non-profit and non-governmental organizations) and households. Exhibit 4: General government expenditure on health as % of total expenditure on health (2013) 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% 83.1% 80.5% United kingdom China 55.8% 54.8% 48.2% 48.1% 47.1% 41.9% 39.0% 32.2% Thailand Malayasia Brazil Russian Federation United States of America Vietnam Indonesia India Healthcare delivery industry size estimated at Rs. 3.8 trillion in Based on health indicators for India released by the WHO s world health statistics survey, CRISIL Research estimates the size of the Indian healthcare delivery industry, in , at Rs. 3.8 trillion. The in-patient department ( IPD ) accounted for 81% of the healthcare delivery industry, and the out-patient department ( OPD ) accounted for the remaining 19%. The in-patient department in a hospital generally consists of beds, operation theatre(s), intensive care unit, supportive services like nursing services, pharmaceutical services, laboratory and diagnostic centers and a central sterile and supply department ( CSSD ). CRISIL Research defines inpatients as patients who require overnight hospitalization. IPD revenues typically include room or bed rentals (including operation theatre charges), consultancy and surgery fees, diagnostic and pathology lab charges (for tests done during IPD stay) and consumables charges. CRISIL Research defines outpatients as patients who are not required to stay at the hospital overnight. OPD also includes consultancy, day surgeries and diagnostics, and excludes pharmaceuticals purchased from standalone outlets. Equity research 3

4 Indian diagnostics industry Market size In the spectrum of healthcare delivery services in India, diagnostic services play the role of an information intermediary, providing useful information for correct diagnosis and treatment of patients diseases. Diagnostic services would have a lower share in overall healthcare spends, yet play a vital role in identifying problem areas and major illnesses. Major diagnostic healthcare service providers in India offer a wide range of healthcare tests and services. The industry can be classified into imaging diagnostics and pathology testing services. Pathology testing or in vitro diagnosis involves reporting diagnostic information on the basis of collected samples (in the form of blood, urine and stool, among others) and then analyzing the samples in a lab to arrive at useful clinical information. Imaging diagnostics, or radiology, involves procedures such as taking X-rays and ultrasounds, which help mark anatomical and physiological changes inside a patient s body to help doctors diagnose the disease. CRISIL Research estimates the size of the diagnostics industry at around Rs. 377 billion in CRISIL Research expects that the diagnostics industry will continue to grow by a CAGR of 16%-17% over the next three years to over Rs. 600 billion by Evidence-based treatment is slowly becoming the norm for many doctors as a correct diagnosis enables correct therapy and faster patient recoveries. Moreover, as literacy rates and disposable incomes rise, households increasingly demand better healthcare facilities and quality of care. This increase has also been boosted by the rise in urbanization and the increase in lifestylerelated diseases such as cardiac diseases, diabetes, hypertension and cancer, among others, prompting many healthcare service providers to enhance their offerings in metropolitan areas, and tier-i and tier-ii cities. Demand drivers for the Indian diagnostic industry Increase in evidence-based treatments Huge demand-supply gap Changing disease profiles Increase in health insurance coverage Need for greater health coverage as population and life expectancy increase Rising income levels make quality healthcare services more affordable Demand for lifestyle diseases-related healthcare services to grow Pathology business accounts for the largest share of the diagnostics industry CRISIL Research estimates that pathology testing has the larger share of the overall domestic diagnostics market. Pathology includes biochemistry, immunology, hematology, urine analysis, molecular diagnostics and microbiology, among others, whereas imaging diagnostics, or radiology, includes, for example, ultrasound, X-ray, CT scan, MRIs and positron emission tomography computed tomography, or PET-CT. Pathology has gained prominence as the preferred line of diagnosis for the majority of diseases, with a gradual increase in the prescription of pathology tests over the past decade. While earlier, doctors would typically rely on clinical assessment in order to diagnose and treat diseases, more recently, evidence-based treatment is slowly becoming the norm as it facilitates a correct diagnosis, and consequently, correct therapy and faster patient recoveries. However, the price for pathology investigation is usually lower than for imaging diagnostic tests such as MRIs, where each test may cost two to three times more than the pathology investigation. Typically, a pathology investigation requires several tests for a patient at one time. Thus, the contribution of pathology tests to the overall diagnostics market continues to be on the higher side as it is conducted more frequently. Equity research 4

5 Biochemistry tests estimated to have a larger share among pathology services As per WHO s statistics on disability-adjusted life years ( DALYs ), the share of the disease burden has been gradually shifting to cardiovascular diseases, diabetes and cancer. Cumulatively, these three diseases comprised close to 19% of the DALYs of the Indian population in 2012, up from 14% in Consequently, biochemistry tests for blood sugar, cholesterol and triglycerides, urea and creatinine, among others, are increasingly being prescribed by doctors to identify such diseases. Increase in health insurance coverage According to the Insurance Regulatory and Development Authority, nearly 216 million people have health insurance coverage in India (as of ), accounting for only 17% of the total population, representing a significant opportunity for growth. The number of persons insured for non-life health insurance has increased by 4.3% during and Due to the increase in the penetration of health insurance coverage, hospitalization rates (the number of times an individual visits a hospital) are also likely to go up, thus increasing the demand for diagnostics tests. Exhibit 5: Health insurance coverage in India Rs. bn Network coverage Total Non Life Health Insurance Premium (LHS) No. of persons insured (RHS) Rs. mn Hub-and-spoke model Company has built a national, hub and spoke network that includes its National Reference Laboratory in New Delhi, 163 other clinical laboratories, 1,340 patient service centers and over 5,000 pickup points as of March 31, Company believe in its hub and spoke model, whereby specimens are collected across multiple locations within a region for delivery to a predesignated clinical laboratory for centralized diagnostic testing, which provides greater economies of scale and offers a scalable platform for the continued growth of its business. Company s network is present across India, including large cities such as New Delhi, Mumbai, Bengaluru, Chennai, Hyderabad and Kolkata. Company s centralized information technology platform are fully integrated with its large network through a common logistics and payments system and tracks its operations and internal performance metrics, thereby enabling it to improve the efficiencies of its business. Equity research 5

6 Exhibit 6: Service Network Source: Company s DHRP Exhibit 7: The below chart depicts the infrastructure of company s network as at March 31, 2015, 2014 and 2013: 2,015 2,014 2,013 Clinical Laboratories Total Patient Service Centers 1, , Owned Patient Service Centers Franchisee Patient Service Centers 1, , Pickup Points 5,667 4,225 2,879 Source : Company s RHP, BOBCAPS Note: 1. Out of our 164 clinical laboratories, six are not owned and operated by them. 2. Of our patient service centers, as of March 31, 2015, 69 were owned by us, and 1,271 were exclusive franchisees. 3. As of March 31, 2015, out of our 164 clinical laboratories, 19 were under laboratory management arrangements. In terms of reporting test results, diagnostic labs may use both online and hard-copy formats. Apart from this, the chains also deploy sales personnel to help collection centers create tie-ups with doctors. The satellite lab is also responsible for the deployment of the sample delivery staff (who help transport samples between collection centers and labs), training of all lab technicians who are employed both at labs, as well as at all collection centers, and all branding and stationary material for the spokes. Reference lab: The reference lab is located centrally, usually in a large metropolitan area, and also typically accumulates samples from satellite labs and collection centers across the country. The reference labs may be equipped to conduct both routine and specialized pathology and radiology tests. Sizes of laboratories may differ as per equipment installed and tests analyzed or services offered, and may also include a work area, front office, back office and a sample collection area. Equity research 6

7 Satellite Labs: Satellite labs offer a limited range of services. They mainly act as feeders for reference labs. Satellite labs may be either owned or franchised by a diagnostic chain company. Collection Centers: Collection centers are located in hospitals, nursing homes, pathology labs, doctors clinics, prime commercial properties and retail spaces, among other places. Collection centers may be company-owned or franchised. A franchisee usually pays a franchise fee, around Rs. 30,000-50,000, to get the license to operate a collection center for a satellite lab. Typically, the collection centers are mainly involved in the collection and forwarding of patient samples to a satellite or reference lab. However, the collection centers of certain chains may also be equipped to conduct some basic tests. The centers usually have basic equipment in the form of a refrigerator and a centrifuge, and employ minimal staff, such as a receptionist, lab technician, attendants and delivery staff. A diagnostic chain consists of a reference lab connected to collection centers (owned and/or franchised) and other reference and satellite labs. A typical satellite lab is usually able to cater to a catchment area with a two to five kilometer radius by itself. However, the reach of the satellite lab expands to a kilometer radius as collection centers act as spokes (a collection center is usually able to cater to an area with a three to five kilometer radius). Exhibit 8: Reference Lab Reference Lab Satellite Labs Satellite Labs Collection Centre Collection Centre Collection Centre Collection Centre Exhibit 9: Satellite lab Equity research 7

8 Functioning of logistics between collection centers and labs Collection centers pick up samples, either directly from customers homes or from the patients at the center itself. The samples are stored as per procedures laid down by the reference labs to maintain the samples integrity. For example, whole blood samples are safely collected in vacuum-filled sterile tubes called vacutainers, appropriately labelled or barcoded, and stored at the appropriate temperature of 4-25 degrees Celsius depending on the type of test recommended. Samples collected at collection centers are picked up by collection personnel, usually two to three times in a day. Every pick-up person from the satellite lab has a specified area of operation and usually handles five to ten centers within a four to five kilometer radius area. Samples from all collection centers of a particular area of operation are rounded up within a single staging area in the city. Then, a single delivery person takes charge of the samples and sends them to the reference lab or satellite labs with routine testing capabilities. The samples are usually transported by road on two-wheelers or other modes of transport. Sample transport usually takes from one hour to one day depending upon the distance between the area of collection and the final drop point and the turnaround time during which the sample can be kept intact. Equity research 8

9 Strength Trusted Brand: The Company is one of the oldest Pathology lab in the country whose brand value is respected a lot by the people. Trust play a very critical part in the minds of the people while taking any decision pertaining to their health. Hence the Company scores highly on this count. Genetic diagnostics: Most medical treatments are designed in a generalized manner that is successful for some patients but not for others. The reason behind the same is the difference in genetic profile of every individual. Personalized medicine is an innovative approach to deal with high end diseases like cancer, neurological diseases, etc for which Genetic profiling is the start point of the whole process. Patients with a variety of cancers and other such diseases routinely undergo genetic testing as part of patient care. Gene sequencing using Next Generation Sequencing collects data on a person s entire genome. Doctors depend on this data to evaluate the gene or family of genes responsible for the disease. Treatments and medications are suggested based on this information to improve chances of survival and reduce exposure to adverse effects. There are very few players in India who are providing supporting specialized diagnostics for the same. Dr. Lal Pathlabs is one of them. Asset Light Business Model: The Company follows an asset light model because of which the company does not have any Long and Short Term borrowings. This leaves a lot of room for the Company to leverage its Balance Sheet at a further date for aggressive expansion, if it chooses to do so. Risks Company relies heavily on its franchisees: Although the company has an impressive network of 1,340 Patient service centers, the company own just 5% of it. Rest all are company s franchisee. Any lapse in the performance of these franchisees will adversely affect the trust and confidence of its customers which is fundamental to its business since the company has no control over the day to day functioning of these franchisees. In an era of social media networking, any adverse instance of this kind can play a havoc on the business of any company that relies so heavily on its franchisee. Highly competitive business segment: The diagnostic healthcare service industry is highly competitive. Further, there is no significant entry barrier in this industry. The pricing of a standalone diagnostic healthcare center may be at a significant discount to the company s rate card as these standalone diagnostic center may operate on lower cost base as compared to a company owning chain of diagnostic center. India being a cost conscious market, pricing often take precedence over quality. Technological advancement in non-invasive diagnostic healthcare tests: Any Technological advancement in Non Invasive healthcare tests that can be performed without the use of specialized diagnostic healthcare service center would adversely affect the business of the company as the patients may not be required to visit such diagnostic healthcare service center at all. Equity research 9

10 Financial snapshot Exhibit 10: Income statement Y/E Mar (Rsmn) FY11 FY12 FY13 FY14 FY15 Net sales 2,380 3,430 4,545 5,602 6,625 growth (%) COGS ,177 1,392 Staff Cost ,016 1,344 Other cost 820 1,258 1,629 2,002 2,301 EBITDA ,005 1,408 1,589 growth (%) Depreciation EBIT ,136 1,307 Interest income Finance Cost Extraordinary/Exceptional items PBT ,192 1,397 Tax Minority interest (4) (5) (5) (7) (8) PAT Non-recurring items Adjusted PAT growth (%) Exhibit 11: Balance Sheet Y/E Mar (Rsmn) FY11 FY12 FY13 FY14 FY15 Cash & Bank balances ,057 1,482 Other Current assets Investments Net fixed assets 1,124 1,145 1,271 1,400 1,510 Goodwill Other non-current assets Total assets 1,697 1,770 2,690 3,515 4,753 Current liabilities ,118 Borrowings Other non-current liabilities Total ,053 1,182 1,319 Share capital Reserves & surplus 878 1,109 1,570 1,512 2,598 Shareholders' funds 928 1,160 1,621 2,315 3,411 Total liabilities 1,697 1,770 2,690 3,515 4,753 Equity research 10

11 Sales and Dealing Team Purvesh Shelatkar Senior Vice President & Head Equity Anil Pawar Senior Manager Dealing Sachin Sambare Manager Dealing /33 Ashwin Patil Executive Dealing Research Team Sectors Vishal Dalmia Head of Research Capital Goods Vaishali Parkar Kumar Analyst Agri, Auto, Defence Padmaja Ambekar Analyst Auto Ancillary, Infra, Midcap Akanksha Tripathi Analyst Footwear, FMCG Rishabh Mehta Associate Textile, FMCG, Infra Hareesha Kakkera Associate BioTechnology, Pharmaceuticals Retail Dealing Team Kshitij Kelkar Kiran Sawardekar Mohan Shinde Debt Dealing Team Minaxi Tiwari UTI Tower, 3rd Floor, South Wing, Bandra-Kurla Complex, Bandra (E), Mumbai India. Ph.: Fax: research@bobcaps.in Web: NSE SEBI No. (CASH): INB NSE SEBI No. (DERIVATIVES): INF BSE SEBI No. : INB The BoB Capital Markets research team hereby certifies that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. 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