Dr Lal PathLabs. Strong, sustainable business model. IPO Review. Price band ICICI Securities Ltd Retail Equity Research. Investment rationale

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1 IPO Review Rating matrix Rating : Subscribe Issue Details Issue Details Issue Opens Issue Closes 8-Dec Dec-15 Issue Size ( crore) Price Band ( ) No. of Shares on Offer (crore) 1.2 QIB (%) 5 Non-Institutional (%) 15.0 Retail (%) 35.0 Objects of issue The offer for sale is essentially to enhance company's visibility and brand and provide liquidity to its existing shareholders and holders of options granted by our Company. Shareholding Pattern Pre-Offer Post-Offer Promoters & Promoter Group Institutions Non-Institutions Public Custodians Financial Summary crore FY11 FY12 FY13 FY14 FY15 Total Revenues EBITDA EBITDA Margins PAT EPS Research Analyst Siddhant Khandekar siddhant.khandekar@icicisecurities.com Mitesh Shah mitesh.sha@icicisecurities.com Nandan Kamat nandan.kamat@icicisecurities.com Strong, sustainable business model December 4, 2015 Dr Lal PathLabs Price band Dr Lal PathLabs (DLPL) is in the business of providing diagnostic & related healthcare tests and services in India. With a cumulative offering of 3,495 diagnostic and related healthcare tests & services, DLPL has proven capability in performing most diagnostic healthcare tests and services currently prescribed by Indian physicians. Its customers include individual patients, hospitals and other healthcare providers as well as corporate customers. DLCP has a pan-india presence with a strong network of 172 clinical laboratories (including a National Reference Laboratory in New Delhi), 1,554 patient service centres & over 7,000 pickup points. Investment rationale Strong business model DLPL s business model is a combination of (i) a hub and spoke model, which facilitates economies of scale and future growth scalability, (ii) an instrument leasing model that results in lower capital expenditure and (iii) a large network, which enhances its purchasing power with suppliers. Also, its centralised information technology platform fully integrates a large network through a common logistics and payments system, thereby allowing it to facilitate seamless sample collection and payments from patients and healthcare service providers. Robust financial performance Revenues have grown at a CAGR of 20.7% to in FY13-15 mainly due to growth in sample collections, which grew at 16.7% CAGR in the same period. The strong growth in sample collection was mainly due to network expansion and enlarged portfolio of diagnostics and related healthcare tests and services. Due to its strong business model, the company maintained robust EBITDA margins (~24% in FY15) with healthy return ratios (RoE-27.9%, RoCE-38.3%). Well poised to cash in on growing Indian diagnostic industry Evidence-based treatment is slowly becoming the norm for many doctors as 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 urbanisation and increase in lifestyle-related diseases. Crisil expects healthcare delivery services to grow at 16-17% CAGR in FY We believe DLPL, with its pan-india presence and reputation for providing quality diagnostic healthcare services, is well positioned to take advantage of the growth of the Indian diagnostic healthcare services industry. Key concern Low entry barriers and sensitivity of brand image. Priced at 46-47x on FY15 EPS of 11.7 At the IPO price band of , the stock is available at 46-47x on FY15 EPS of We recommend that investors SUBSCRIBE to the issue.

2 Exhibit 1: Key Financials crore FY11 FY12 FY13 FY14 FY15 H1FY16 Total Revenues EBITDA EBITDA Margins PAT EPS RoE RoCE Company Background Incorporated in 1949 by Dr Major SK Lal, Dr Lal PathLabs (DLPL) is in the business of providing diagnostic and related healthcare tests and services in India. With a cumulative offering of 3,495 diagnostic and related healthcare tests and services, DLPL has proven capability in performing most diagnostic healthcare tests and services currently prescribed by physicians in India. The company s customers include individual patients, hospitals and other healthcare providers as well as corporate customers. The diagnostic and related healthcare tests and services by DLPL include (i) routine clinical laboratory tests such as blood chemistry analysis and blood cell counts; (ii) specialised testing services such as histopathology (tissue) analysis, 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. The company performs these tests and services in its clinical laboratories using advanced computerised instruments. The company has built a national hub and spoke network that includes National Reference Laboratory in New Delhi, 171 other clinical laboratories, 1,554 patient service centres and more than 7,000 pickup points as of September 30, Under this model, specimens are collected across multiple locations within a region for delivery to a predesignated clinical laboratory for centralised diagnostic testing, which provides economies of scale and offers a scalable platform for the continued growth of our business. DLPL has a pan-india presence, including large cities like New Delhi, Mumbai, Bengaluru, Chennai, Hyderabad and Kolkata. In FY15, the company has collected 2.18 crore samples across India. Exhibit 2: DLPL s service network No. of Units FY13 FY14 FY15 H1FY16 Clinical Laboratories Total Patient Service Centers 824 1,064 1,340 1,554 Owned Patient Service Centers Franchise Patient Service Centers 776 1,009 1,271 1,475 Pick up Points 2,879 4,225 5,667 7,059 Page 2

3 Exhibit 3: Geography wise revenue break-up ( crore) FY13 FY14 FY15 H1FY16 North East South West International Total Exhibit 4: Service network Exhibit 5: Key events Year Event 2005, 2007 Investment by WestBridge I Investments Holdings Acquisition of Paliwal Medicare Private Limited and Paliwal Diagnostics Private Limited Establishment of our National Reference Laboratory. 2010, 2013 Investment pursuant to purchase of shares by Wagner Limited from WestBridge I Investment Holdings Investment pursuant to purchase of shares by WestBridge Crossover Fund, LLC from WestBridge I Investment Holdings Investment by SIH Acquisition of APL Clinical Institute of Clinical Laboratory & Research Private Limited. Amalgamation of Sanya Chemicals Private Limited, Amolak Diagnostics Private Limited, Medex Healthcare Private Limited, Medicave Diagnostic Centre 2015 Private Limited, Medicave Medical Systems Private Limited and our Company. Page 3

4 Indian diagnostics industry The diagnostic industry is classified into imaging diagnostics and pathology testing services. 1) 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 analysing the samples in a lab to arrive at useful clinical information 2) 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 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. Crisil Research estimates the size of the diagnostics industry at around crore in FY15. It expects the diagnostics industry to continue to grow at a CAGR of 16-17% over the next three years to over crore by FY18. Major diagnostic healthcare service providers in India offer a wide range of healthcare tests and services. Crisil Research estimates that pathology testing has the larger share of the overall domestic diagnostics market. Pathology includes biochemistry, immunology, haematology, 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. Exhibit 6: Break-up of pathology testing by services (FY15E) Others, 22% Biochemistry, 39% Hematology, 18% Immunology, 21% Diagnostic centres in India can be classified into three types: hospitalbased centres, diagnostic chains, standalone centres. Page 4

5 Exhibit 7: Diagnostic centres classification Diagnostic Chains 15% Stand alone centers 48% Hospital based 37% Standalone centres Standalone centres make up 48% of the diagnostics industry. The absence of stringent regulations and low entry barriers has also helped small pathology labs and radiology centres to proliferate across the country. These labs typically carry out basic tests, which require minimal investments and space. Standalone radiology centres typically have a conventional X-ray and an ultrasound machine. Hospital-based diagnostic centres Usually, secondary and tertiary hospitals run their own pathology labs and radiology centres. However, some hospitals outsource the management of their diagnostic facilities to third-party service providers. Tertiary hospitals, which may not have the equipment to conduct advanced tests, may also send the samples to other laboratories. Given that equipment for advanced tests is expensive, many tertiary hospitals find them economically unviable due to a lack of testing volumes. For example, a hospital may have a machine to test whether a patient is HIV positive or not but to determine a virus count, the sample will have to be sent to a specialised pathology lab. Diagnostics chains Currently, some of the major diagnostics chains in India besides DLPL include Thyrocare, SRL Diagnostics and Metropolis, among others. These service providers have a pan-india presence and offer pathology and/or radiology services. Diagnostics chains adopt a hub-and-spoke model, which helps them increase their presence in the catchment area. Radiology centres for diagnostics chains are mainly present in major urban centres. They do not operate on the hub-and-spoke model, as tests are conducted within the radiology centre itself. Hub-and-spoke model of chain diagnostics centres The components of a hub-and-spoke model typically include a reference lab, satellite labs and collection centres. Page 5

6 Exhibit 8: Hub-and-spoke model es Reference Lab Satellite Labs Satellite Labs CC CC CC CC ; CC: Collection Centres Reference lab: The reference lab is located centrally, usually in a large metropolitan area, and also typically accumulates samples from satellite labs and collection centres across the country. The reference labs may be equipped to conduct both routine and specialised pathology and radiology tests. Sizes of laboratories may differ as per equipment installed and tests analysed or services offered, and may also include a work area, front office, back office and a sample collection area. 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 centres: Collection centres are located in hospitals, nursing homes, pathology labs, doctors clinics, prime commercial properties and retail spaces, among other places. Collection centres may be companyowned or franchised. A franchisee usually pays a franchise fee, around 30,000-50,000, to get the license to operate a collection centre for a satellite lab. Typically, the collection centres are mainly involved in the collection and forwarding of patient samples to a satellite or reference lab. However, the collection centres of certain chains may also be equipped to conduct some basic tests. The centres 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. Page 6

7 Investment Rationale Strong business model with centralised information technology DLPL s business model is a combination of (i) a hub and spoke model, which facilitates economies of scale and future growth scalability, (ii) an instrument leasing model that results in lower capital expenditure and (iii) a large network, which enhances its purchasing power with suppliers. Exhibit 9: Increase in collection and patients volume (crore) FY13 FY14 FY15 CAGR % (FY13-15) Sample Collection Patients Centralised information technology platform DLPL s centralised information technology platform fully integrates a large network through a common logistics and payments system, thereby facilitating samples collection and payments from patients and healthcare service providers in a seamless manner. Similarly, its centralised technology platform gives healthcare providers convenient, online access to diagnostic results. Furthermore, the growth of its network is supported by the scalability of its technology platform, which readily can adapt to the increased data requirements of additional clinical laboratories and patient service centres. Robust financial performance Revenues grew at a CAGR of 20.7% to in FY13-15 mainly due to growth in sample collection at 16.7% CAGR over the same period. The strong growth in sample collection was mainly due to network expansion and enlarged portfolio of diagnostics and related healthcare tests and services. Due to its strong business model, the company has maintained robust EBITDA margins (~24% in FY15) with healthy return ratios (RoE- 27.9%, RoCE-38.3%). Well poised to cash in on growing Indian diagnostic industry 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 urbanisation and increase in lifestyle-related diseases such as cardiac diseases, diabetes, hypertension and cancer, among others. This has prompted many healthcare service providers to enhance their offerings in metropolitan areas and tier-i and tier-ii cities. Crisil expects healthcare delivery services to grow at 16-17% CAGR in FY DLPL has built a national network consisting of one National Reference Laboratory in New Delhi, 171 other clinical laboratories and 1,554 patient service centres as of H1FY16. We believe that with DLPL s pan-india presence including metropolitan areas like New Delhi, Mumbai, Bengaluru, Chennai, Hyderabad and Kolkata with its long operating history and reputation for providing quality diagnostic healthcare services is well positioned to take advantage of the growth of the Indian diagnostic healthcare services industry. Page 7

8 Financials Revenues increase at CAGR of 29.1% over FY11-15 Revenues grew at a CAGR of 29.1% in FY11-15 to crore mainly due to an increase in sample collection. The strong growth in sample collection was mainly due to network expansion and increase in the portfolio of diagnostic and related healthcare tests and services. Exhibit 10: Revenue trend Exhibit 11: Geographical revenue break-up crore FY11 FY12 FY13 FY14 FY15 Total Revenues crore FY13 FY14 FY15 H1FY16 North East South West International Maintains robust EBITDA margin trend EBITDA margins have remained in a range of 22-25% in FY Excluding MTM losses pertaining to Esops, the EBIDTA margin increased ~320 bps to 27.7% during same period. Exhibit 12: EBITDA & PAT margins trend 3 % FY11 FY12 FY13 FY14 FY15 H1FY16 EBITDA Margins PAT Margins Net profit increases at 34% CAGR in FY11-15 Net profit grew at 33.9% CAGR over FY11-15 to 95 crore mainly due to a strong operational performance. Page 8

9 Exhibit 13: Net profit trend crore FY11 FY12 FY13 FY14 FY15 PAT Healthy return ratios Exhibit 14: Return ratios trend % FY11 FY12 FY13 FY14 FY % RoE RoCE Exhibit 15: Net debt/equity Leverage free balance sheet with sustainable cash flows Due to its assets light model, the balance sheet is leverage free. Similarly, due to a low cash conversion cycle and a strong operational performance, the company has cumulatively generated 246 crore of free cash flow by FY15. Exhibit 16: Free cash flow FY11 FY12 FY13 FY14 FY15 crore FY11 FY12 FY13 FY14 FY15 Net Debt/Equity FCF Page 9

10 Key concerns Low entry barriers In the absence of governmental regulation, the diagnostic healthcare services industry in India is highly competitive and has low entry barriers. The laboratories through which it provides diagnostic healthcare services are clinical establishments under several state legislations as well as the Clinical Establishments (Registration and Regulation) Act, 2010 and the Clinical Establishments 24 (Central Government) Rules, These legislations provide for registration and regulation of clinical establishments in India and prescribe minimum standards and chargeable rates for facilities & services provided by them and penalties in case of any contravention with such laws and rules there under. Brand image The reputation of the brand is fundamental to all aspects of its business. The quality and reputation of diagnostic healthcare services can be adversely impacted if its staff or business partners make errors in the handling and labelling of patient samples and specimens, misuse or ineffectively use the complex medical equipment, inadequately extract samples and specimens from patients causing bodily harm or affecting its ability to properly conduct the required testing. Valuations At the IPO price band of , the stock is available at 46-47x on FY15 EPS of We recommend that investors SUBSCRIBE to the issue. Objects of issue The offer for sale is essentially to enhance the company's visibility & brand and provide liquidity to its existing shareholders and holders of options granted by the company. Page 10

11 Financial summary Profit and loss statement ( Crore) FY11 FY12 FY13 FY14 FY15 Revenue from operations Growth (%) NA Raw Materials % of sales Employee expenses Other expenses Total expenses EBITDA Depreciation and amortisation e Interest Income Finance costs EBT Tax Tax rate (%) PAT before MI Owners of the Parent Minority Interest PAT Diluted EPS Source: Company, ICICIdirect.com Research Balance sheet Crore ( Crore) FY11 FY12 FY13 FY14 FY15 Liabilities & Share Holding Funds Share capital Reserves & surplus Minority Interest Non-Current Liabilities Long term borrowings 4.1 Deferred tax liabilities (net) Trade payables Other long term liabilities Long term provisions Current Liabilities Short term borrowings Trade payables Other current liabilities Short term provisions Total Assets Non-Current Assets Goodwill on consolidation Fixed Assets Deferred tax assets (net) Long term loans and advances Other non-current assets Current Assets Current Investments Inventories Trade receivables Cash and bank balances Short term loans and advances Other current assets Total Source: Company, ICICIdirect.com Research Cash flow statement Crore ( Crore) FY11 FY12 FY13 FY14 FY15 Net profit before tax Depreciation / amortisation Net Increase in Current Assets Net Increase in Current Liabilities Other Operating Activities CF from operating activities (Purchase)/Sale of Fixed Assets (Purchase)/Sale of Investment Other Investing Activities CF from investing activities Proceeds from issues of Shares Inc/(dec) in loan funds (Payment) of Dividend and Div Tax Interest Paid Other Financing Activities CF from financing activities Net Cash flow Opening Cash Closing Cash Source: Company, ICICIdirect.com Research Key ratios Ratio Sheet FY11 FY12 FY13 FY14 FY15 Per share data ( ) Reported EPS Cash EPS BV per share Cash Per Share Operating Ratios (%) Gross Profit Margins EBITDA Margins PAT Margins Inventory days Debtor days Creditor days EBITDA Conversion Rate Return Ratios (%) RoE RoCE RoIC Valuation Ratios (x) EV / Net Sales Market Cap / Sales Price to Book Value Solvency Ratios Debt / EBITDA 0.3 Debt / Equity 0.2 Net Debt/ Equity Current Ratio Quick Ratio Source: Company, ICICIdirect.com Research Page 11

12 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai research@icicidirect.com Page 12

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