Near-term margin concerns and valuations weigh on Dr Lal Pathlabs

Some brokerages prefer Metropolis given higher realisation, revenue growth trajectory

The Dr Lal Pathlabs stock has shed about 15 per cent from its highs a week ago after brokerages downgraded it over concerns related to realisation pressures, higher competition, and near-term margin pressures. Prior to the recent correction, the stock had gained 45 per cent since the start of March, running ahead of growth expectations. After Nomura downgraded the stock last week, CLSA, too, put a “sell” rating on Tuesday.

 While most brokerages are bullish over the long-term prospects of the sector and diagnostic companies, including Dr Lal Pathlabs, they flag near-term concerns. Lower realisations on a sequential basis because of Covid-related tests despite the surge in volumes can be an overhang. Metropolis in its Q4FY21 update highlighted that though volumes went up, its share in revenues was down due to a reduction in test prices.

The average realisation per Covid test, which was Rs 2,500-Rs 3,500 per test at the initial stages of the pandemic, came down to Rs 1,000 to Rs 1,500 per test in the December quarter and is now hovering at Rs  700-Rs 800 per test now, according to analysts at Nomura Research. For Dr Lal, the drop in realisations from Covid tests is 46 per cent over the first three quarters of FY21.

With Covid revenues witnessing a 50 per cent jump for the company in March as compared to December/January, lower realisations can weigh on margins. While non-Covid volumes had hit the pre-pandemic levels in the first half of the March quarter and this is positive, the lockdown in Delhi (Delhi-NCR accounts for a major share of revenues) could impact the same.

Though there is an opportunity to gain market share from unorganised players, the price run is not factoring in key risks. Analysts at CLSA believe it will be difficult for the company to deliver on lofty expectations given the intense competition and near-term margin headwinds from the company’s ongoing expansion into the south and west regions of the country.

Nomura Research, too, expects limited upside in operating profit margins due to competitive pressure from the existing and new entrants (e-commerce players, hospitals, and pharma companies).

Analysts at IIFL Securities prefer Metropolis over Dr Lal, given the former’s aggression on the acquisition front, organic expansion, and the highest realisations in the industry with specialised tests accounting for 40 per cent of its revenues. Moreover, the valuation of Dr Lal (stock trades at 62 times its FY23 earnings estimates) is at a 40 per cent premium to Metropolis, though it has a similar B2C-led model and relatively lower earnings growth projection over the FY21-23 period.