Initiating Coverage. Dr Lal Path Labs Ltd. 1 P a g e. related healthcare tests and services in India. Dr Lal Path Labs has strong.

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1 4 Recommendation BUY Dr Lal Path Labs (DLPL) is India s second largest provider of diagnostic and related healthcare tests and services in India. Dr Lal Path Labs has strong CMP Rs 973 pedigree of promoters. Target Price 15-20% Sector Stock Details Healthcare BSE Code NSE Code Bloomberg Code LALPATHLAB DLPL IN Market Cap (Rs cr) 7945 Free Float (%) wk HI/Lo (Rs) 1279/793 Avg. volume BSE+ NSE (Qrty) 194,710 Face Value (Rs) 10.0 Dividend (FY 16) 24.5% Shares o/s (Cr) 8.3 Relative Performance 1Mth 3Mth 1Yr DLPL 4.3% -9.7% 3.3% Sensex 3.7% 12.3% 18.4% Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Shareholding Pattern 31 st Dec 16 Promoters Holding Institutional (Incl. FII) Corporate Bodies Public & others 5.34 Runjhun Jain Sr. Research Analyst runjhun.jain@nirmalbang.com Investment Rationale Growing Industry: CRISIL Research estimates the size of the diagnostics industry at around Rs 377 billion in and expects it to grow by a CAGR of 16%-17% over the next three years to over Rs 600 billion by led by Evidence-based treatment which is slowly becoming the norm for many doctors as a correct diagnosis enables correct therapy and faster patient recoveries. Organised players eating up unorganised market share: With inherent cost efficiencies in their business model, the chains are able to offer competitive prices as compared with other service providers in the market. Diagnostic chains also focus on creating a better brand name to increase patient walkins. CRISIL Research believes that the share of pan india diagnostic chains in the overall market will increase to 16% by on account of a robust CAGR of 19% over the next three years. Strong Brand: Dr Lal Path Labs (DLPL) is India s second largest provider of diagnostic and related healthcare tests and services. We believe the company enjoys strong brand recall based on its integrated model and its focus on quality and reliability of diagnostic services. Robust Financials: The company has demonstrated strong growth over last 4-5 years. Sales have grown at CAGR of 23.3% over FY12-16 with higher growth in EBITDA of 24.8% over the same period. EBITDA Margins are on stable to improving trend. DLPL is a net debt free company with strong ROE of 26.3% in FY16. Valuation & Recommendation Between FY12-16 DLPL s revenues grew at CAGR of 23.3% while EBIDTA grew at a CAGR of 24.8% and PAT by 31.1%. We expect DLPL to maintain healthy growth rate of 15-20% going forward as well, on the back of expansion of its base, opening of 2 new national reference laboratories, eating share of standalone laboratories and increase spend by people on preventive and curative healthcare. At the time of IPO the stock was offered at 24x PE on trailing PE however we had justified the premium valuation by comparing it with consumer companies due to its consumer centricity. Post its listing in Dec 15, DLPL has been trading between 40x-50x one year forward PE. However, due to dull Q3FY17, the stock has corrected 33% from its peak. At CMP, the stock is trading at 41x FY18E consensus earnings which we believe gives an attractive opportunity to enter a high quality stock. Considering the healthy balance sheet, improving growth prospects and strong profitability, We recommend BUY on Dr Lal Path Labs for 15-20% upside in 3-6 months. Year Consol Sales (Rs cr) Growth (%) EBITDA (Rs cr) Margin (%) PAT (Rs cr) Margin (%) Adj EPS (Rs) P/E (x) RoE FY13A % % % % FY14A % % % % FY15A % % % % FY16A % % % % 1 P a g e

2 INVESTMENT RATIONALE Growing Industry India total expenditure on healthcare is 4% of GDP (WHO) which trails not only developed countries (~10%) but also developing countries (5-6%). This is due to underpenetration of healthcare services and lower consumer spending on healthcare. 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 Rs 377 billion in and expects it to grow by a CAGR of 16%-17% over the next three years to over Rs 600 billion by led by Evidence-based treatment which is slowly becoming the norm for many doctors as a correct diagnosis enables correct therapy and faster patient recoveries. Additionally, increase in literacy rates and disposable income is boosting the preventative healthcare and volume of pathology tests. Organised players eating up unorganised market share The diagnostics industry is highly competitive with the presence of standalone centers, hospital-based labs and diagnostic chains. o Hospital Based centers (37%) o Diagnostic centers (15%; pan india chains 35-40% and regional chains 60-65%) o Standalone centers (48%) A large number of hospitals are also unorganized hence it is safe to assume to that almost 70% of market come under unorganized segment. To counter such intense competition, a diagnostic chain usually opens more collection centers in an area, which enables it to cater to a larger catchment area. Moreover, with inherent cost efficiencies in their business model, the chains are able to offer competitive prices as compared with other service providers in the market. Diagnostic chains also focus on creating a better brand name to increase patient walk-ins through strategies such as organizing health camps, launching testing various packages (where five or six routine tests are offered at lower prices) and offering home collection facilities, and so on. CRISIL Research believes that the share of pan india diagnostic chains in the overall market will increase to 16% by on account of a robust CAGR of 19% over the next three years. Strong Brand Establishing a strong brand name in diagnostics business is essential as it helps to increase patient walk-ins. Dr Lal Path Labs (DLPL) is India s second largest provider of diagnostic and related healthcare tests and services. We believe the company enjoys strong brand recall based on its integrated model and its focus on quality and reliability of diagnostic services. Hub & Spoke Model DLPL adopts the hub-and-spoke model to extend its catchment area. The components of a hub-and-spoke model typically include a reference lab, satellite labs and collection centers. This helps the company to achieve incremental volume and revenue. Larger volumes also helps it to achieve economies of scale and offers a scalable platform for the continued growth of the business. 2 P a g e

3 *CC = Collection centers The company s core market is North India (72% of sales) however Central and Eastern India also plays significant role (13% of sales). Currently DLPL has one National Reference Laboratory in New Delhi with 172 other clinical laboratories, 1559 patient service centers and around 5000 pickup points. The company is now expanding further in Central and Eastern India through the construction of regional reference laboratories, including a large, regional reference laboratory in Kolkata and Lucknow combined with the opening of additional smaller clinical laboratories and several new, complementary patient service centers. It is also expanding in Southern and Western India by opening additional clinical laboratories and patient service centers. Robust Financials: The company has demonstrated strong growth over last 4-5 years. Sales have grown at CAGR of 23.3% over FY12-16 with higher growth in EBITDA of 24.8% over the same period. EBITDA Margins are on stable to improving trend. DLPL is a net debt free company with strong ROE of 26.3% in FY16. Being a pioneer in the segment, we believe DLPL would be able to maintain healthy growth rates and stable margins going forward on the back of (i) the growth of its network as well as the expansion of the portfolio of diagnostic and related healthcare tests and services, (ii) improvements in the operating efficiency, including management of costs and expenses, (iii) lower capital expenditure model, including use of a reagent rental model (leasing of equipment), which lowers company s capital expenditures for diagnostic equipment and (iv) its strategy of prioritizing resources and investments in accordance with their significance to the business. 3 P a g e

4 COMPANY OVERVIEW Dr Lal Path Labs (DLPL) is India s second largest provider of diagnostic and related healthcare tests and services in India. They provide 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. Their customers include individual patients, hospitals and other healthcare providers and Corporate customers. Dr Lal Path Labs has strong pedigree of promoters. Late Dr. Major S.K. Lal, commenced the business of providing pathology services and maintaining a blood bank in the year Subsequently, Late Dr. Major S.K. Lal and (Hony.) Brig. Dr. Arvind Lal (current CMD) continued the business. However, the company is run by experienced professionals. Region Wise Breakup International, 1% South, 6% West, 9% East, 13% North, 72% 4 P a g e

5 QUARTERLY RESULT Stdalone (Rs cr) Q3FY15 Q4FY15 FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 FY16 Q1FY17 Q2FY17 Q3FY17 Net sales Cost of Materials Staff cost Other Exps Total Expenses EBITDA margins 24.6% 25.5% 23.6% 26.0% 16.8% 37.1% 27.4% 26.5% 27.1% 30.4% 22.6% Depreciation EBIT Interest Other income PBT Tax Tax rate 33.1% 26.3% 31.0% 33.8% 32.2% 33.6% 34.4% 33.6% 33.0% 33.4% 33.3% MI & EO PAT Equity Capital FV EPS Q3 results were impacted due to demonization as business was highly dependent on physical cash paying patients. Hence the volume was subdued at 5% and sales growth came down to 10% from average 20% earlier. Despite this, the management is confident of growth. Hub and Spoke Model No of Clinical Labs FY FY FY FY No of Patient Service Centers FY FY FY FY No of Collection centers FY FY FY FY P a g e

6 PEER COMPARISON Given the strong cash flow generation, robust return ratios and healthy financials we believe it is more appropriate to compare DLPL with consumer companies. We are also comparing it with Thyrocare technologies (only other listed Diagnostics companu) however we believe that DLPL would always be valued at premium to Thryocare due to brand value it holds. Godrej Consumer Jubilant Foods Asian Paints Thyrocare Dr Lal Path FY16 Sales CAGR FY % 24.4% 10.1% 21.9% 23.3% EBITDA FY margins 18.1% 11.4% 19.7% 41.5% 27.1% WC Cycle ROCE 16.6% 10.8% 31.6% 16.4% 26.2% ROE 15.0% 10.8% 31.1% 16.4% 26.2% FY18E EPS FY18E P/E RISKS Intense Competition: India s diagnostics industry is highly competitive with standalone centers having close to a 48% market share, compared to around 37% for hospital-based diagnostic centers. This increases competition for organized diagnostic. Also, recently the management has indicated that the sector has seen heightened levels of PE backed deals which is increasing the competitive intensity is the Diagnostics space. Geographical concentration: Many small diagnostic chains operating three or four labs in a particular location or region are susceptible to the supply and demand dynamics of that specific location. Margin dilution: The management has been reriterating that margins are expected to come down over the years as the company is in investing in new territories. 6 P a g e

7 VALUATION AND RECOMMENDATION Between FY12-16 DLPL s revenues grew at CAGR of 23.3% while EBIDTA grew at a CAGR of 24.8% and PAT by 31.1%. We expect DLPL to maintain healthy growth rate of 15-20% going forward as well, on the back of expansion of its base, opening of 2 new national reference laboratories, eating share of standalone laboratories and increase spend by people on preventive and curative healthcare. The strength of the business model can be seen from the first 6MFY17 results. It posted sales growth of 20% with ~700 bps improvement in margins to 29%. Though the management has reiterated that the margins are likely to come off slightly on account of new centers commencement, we believe EBITDA margins would settle somewhere near FY16 level of 26-27%. Q3FY17 was an aberration and we expect growth to normalize from Q1FY18 onwards. At the time of IPO the stock was offered at 24x PE on trailing PE however we had justified the premium valuation by comparing it with consumer companies due to its consumer centricity. The company has zero working capital and 4.2x asset turnover which enables the company to have higher scability with healthy ROCE. Post its listing in Dec 15, DLPL has been trading between 40x-50x one year forward PE. However, due to dull Q3FY17, the stock has corrected 33% from its peak. At CMP, the stock is trading at 41x FY18E consensus earnings which we believe gives an attractive opportunity to enter a high quality stock. Considering the healthy balance sheet, improving growth prospects and strong profitability, We recommend BUY on Dr Lal Path Labs for 15-20% upside in 3-6 months. 7 P a g e

8 Financials Consolidated Rs cr Profit & Loss FY13A FY14A FY15A FY16A Balance Sheet FY13A FY14A FY15A FY16A Net Sales Share Capital % change 32.0% 23.5% 18.2% 20.0% Reserves & Surplus EBITDA Net Worth EBITDA margin 21.6% 24.8% 23.6% 26.5% MI & Share Appln Depn & Amort Total Loans Operating income Other LT Liab Interest Trade Payables Other Income Other CL PBT Total Liabilities Tax Net Fixed Assets MI & EO Capital WIP PAT Goodwill PAT margin (%) 12.3% 14.4% 14.6% 16.8% Investments Sh o/s - Diluted Cash & Bank Adj EPS Inventories Cash EPS Debtors Qtrly-Stdalone Mar.16 June.16 Sept.16 Dec.16 L&A & Others Revenue Total Assets EBITDA Cash Flow FY13A FY14A FY15A FY16A Dep & Amorz Op CF before tax Op Income Change in WC Interest Tax Other Inc CF from Operation PBT Capex Tax Oth Inc & Investme EO CF from Investing PAT Financing EPS (Rs.) Diviend Paid Performance Ratio FY13A FY14A FY15A FY16A Share Capital EBITDA margin(%) 21.6% 24.8% 23.6% 26.5% Loans EBIT margin (%) 17.1% 20.0% 19.4% 22.9% Interest PAT margin (%) 12.3% 14.4% 14.6% 16.8% Others ROE (%) 34.3% 34.7% 28.3% 26.3% CF from Financing ROCE (%) 47.5% 47.9% 37.5% 35.8% Net Chg. in Cash PAT growth (%) 23.2% 100.2% 83.4% 38.2% Cash at beginning Debt/Equity (x) Cash at end Valuation Ratio FY13A FY14A FY15A FY16A Per Share Data FY13A FY14A FY15A FY16A PE (x) Adj EPS Price/BV (x) BV per share EV / Sales Cash per share EV / EBITDA Dividend per share P a g e

9 Disclaimer: Nirmal Bang Securities Private Limited (hereinafter referred to as NBSPL ) is a registered Member of National Stock Exchange of India Limited, Bombay Stock Exchange Limited and MCX stock Exchange Limited. We have been granted certificate of Registration as a Research Analyst with SEBI. Registration no. is INH for the period to NBSPL or its associates hold more than 1% financial interest/beneficial ownership in the company covered by Analyst. NBSPL or its associates/analyst has not received any compensation from the company covered by Analyst during the past twelve months. NBSPL /analyst has not served as an officer, director or employee of company covered by Analyst and has not been engaged in market making activity of the company covered by Analyst. The views expressed are based solely on information available publicly and believed to be true. Investors are advised to independently evaluate the market conditions/risks involved before making any investment decision. Nirmal Bang Research (Division of Nirmal Bang Securities Pvt. Ltd.) B-2, 301/302, Marathon Innova, Opp. Peninsula Corporate Park Off. Ganpatrao Kadam Marg Lower Parel (W), Mumbai Board No. : /8001 Fax. : P a g e