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Representing 7% of healthcare, Indian diagnostic chains on cusp of inflection

In its latest report, domestic brokerage firm Emkay Global has initiated coverage on diagnostic stocks such as Dr Lal Path Labs, Metropolis Healthcare, and Vijaya Diagnostics.

The brokerage emphasised that the Indian healthcare landscape post pandemic is poised to capitalise on structural tailwinds such as heightened consumer awareness, favorable demographics, rise in lifestyle related diseases, and substantial public sector investments in infrastructure.

According to the brokerage, the country’s healthcare expenditure, currently at only 3% of GDP, has historically lagged behind global counterparts due to higher ‘out of pocket’ expenses (51%), and lower health insurance penetration (39%).

However, with diagnostics representing approximately 7% of the healthcare industry, there’s significant potential for growth as India focuses on enhancing spending on essential healthcare services.

Despite competition from branded hospital diagnostics chains and hyperlocal standalone centres, Indian specialised diagnostics chains have managed to increase their market share from 15% to 18% over the past five years. With competitive intensity reducing after emergence of the new normal post pandemic, the brokerage believes Indian organised diagnostics chains stand at the cusp of inflection.

“Additionally, tempered expectations following the significant run-up during the pandemic now present investors with an unassailable opportunity to participate in the burgeoning healthcare industry via organized diagnostics chains,” the brokerage added.

Tempered expectations present an opportunity
Valuation multiples for diagnostics companies expanded significantly (1.5x vs. LTA) during the pandemic. However, post Covid, multiples have reverted to their historical average as they grappled with finding the new normal, given Covid-based revenues shrinking faster than expected.

Diagnostics chains offer quick scalability and higher profitability and are asset-light, thereby commanding higher multiples versus larger peer hospitals. However, following normalisation of growth post pandemic, the EV/EBITDA premium of diagnostics has reduced from 2x to a mere 23% pre-Covid to post-Covid, Emkay noted.

Target price
The brokerage has assigned a ‘buy’ rating to Dr Lal Path Labs, setting a target price of ₹2,800 per share. Dr Lal Path Labs is the undisputed market leader in the diagnostics space.

The brokerage suggests that the company’s exceptional track record in executing strategies, along with its asset-light business model, strong brand reputation, and specialised testing capabilities, will continue to enhance its market dominance.

It expects the company to clock a sales CAGR of 12% over FY24–26E, with the margin remaining flat owing to network expansion and branding-related investments.

Similarly, a ‘buy’ rating has been assigned to Metropolis Healthcare with a target price of ₹2,200 per share. MHL has been able to transition from being a challenger regional operator into the third-largest pan-India diagnostics chain, leveraging its specialised offerings and brand loyalty with the medical fraternity.

According to the brokerage, the company’s tiered strategy and aggressive network expansion plan will fortify its leadership position in focus cities as well as expand coverage in seeding and other cities.

Furthermore, the brokerage has assigned an ‘add’ rating to Vijaya Diagnostics, setting a target price of ₹725 per share. Highlighting the company’s distinctive business model, the brokerage noted that it has effectively addressed the fundamental challenge of achieving profitable scalability in the diagnostics industry.

Elevated upfront capex and high attrition convolute the radiology segment in terms of scale-up, unlike pathology, where most organised and online players scramble for market share.

Vijaya’s higher concentration of B2C revenues (94%), strong brand equity in home markets, and skew towards radiology (35% of the business) are likely to support industry-best margins, whereas aggressive network expansion in Pune and Kolkata will keep return ratios muted, as per the brokerage. LiveMint

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