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Dr Lal PathLabs a well recognised brand in the Diagnostic Sector

Dr Lal PathLabs (DLPL) is the second largest diagnostic chain in India with 172 clinical laboratories, 1554 patient service centers and over 7059 pickup centers on pan India basis. It operates in hub and spoke
model, with presence across major cities like Delhi, Mumbai, Bengaluru, Chennai, Hyderabad and Kolkata. DLPL is capable of performing 1813 pathological tests, 1555 radiology and cardiology tests as well as services that cover a range of specialties and disciplines. In FY16, DLPL had collected and processed ~21.8 mn samples from ~9.9 mn patients.

Asset light business model:

  1. The hub and spoke model enables the company to achieve greater economies of scale which will reduce cost per test also a scalable model for future growth.

  2. The size of its network provides it greater bargaining power with suppliers, thereby allowing it to reduce costs and improve its profit margin.

  3. The company has adopted an asset light model where in it leases equipment thereby reducing the upfront capital cost [instrument leasing model that results in lowered capital expenditures for diagnostic equipment].

  4. DLPL performs its tests and services on equipment and instruments which generally are leased under a “reagent rental” model.

Fully integrated operations:

DLPL’s centralized information technology platform fully integrates its large network through a common logistics and payments system, thereby allowing it to collect more efficiently samples and payments from patients and healthcare service providers. In addition, its technology platform tracks its operations and internal performance metrics, thereby enabling it to improve the operating efficiency of its business. Furthermore, the growth of the network is supported by the scalability of the technology platform, which readily can adapt to the increased data requirements of additional clinical laboratories and patient service centers. Also, the number of tests increases, the cost per test declines, giving economies of scale to the company.

Market Share:

The company’s core markets are North India (72% of sales) as well as Central and Eastern India (13% of sales). DLPL is further strengthening its position in North India by opening new franchised patient service centers across the region in order to expand its network’s reach. It is also expanding its presence in Central and Eastern India through the construction of regional reference laboratories, including a large, regional reference laboratory in Kolkata combined with the opening of additional smaller clinical laboratories and several new, complementary patient service centers.

Dr Lal Path Labs is also expanding in Southern and Western India by opening additional clinical laboratories and patient service centers.

Product Mix and Revenue Break up:

DLPL has a revenue break up of their test in below category.

  1. Biochemistry 39% [Sugar & Lipid Profile 29-31 % , Other tests 69-71 %]

  2. Immunology 21%

  3. Hematology 18%

  4. Others 22%

Well-positioned to leverage segment growth:

The Company is well-positioned to leverage upon one of the fastest-growing segments of the Indian healthcare industry. Diagnostics segment is a fragmented market and dominated by unorganized players (with single lab – 48% or associated to hospitals – 37%). Diagnostics chain players constitute just 15% of market and out of this 60% are with players with just 2 labs. DLPL is second largest diagnostics chain in India.

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 860 billion by 2020-2021.

I believe the company has enjoys strong brand recall based on its integrated model and its focus on quality and reliability of diagnostic services (for example, many of its clinical laboratories are National
Accreditation Board for Testing and Calibration Laboratories (NABL) and its National Reference Laboratory is CAP accredited – international accreditation).

Growth Strategy:

They are mainly focusing on volume growth in account for low margin area.

Focusing on tie-ups with various hospitals to manage their pathology in a vision to become leading pan Indian brand. Hence the margin might be lower in future.

Stepping in Preventing health care and wellness to incur the leverage of this sector.

Management Pedigree:

In a management, what I look for is honesty, performance & aggression. I found all three in their management.

Dr. Arvind Lal and Dr.Vandana Lal are veteran name in this sector with strong medical background and depth knowledge in this arena.

First thing that attract me is their honesty of declaring a possible margin contraction of 6-7% due to their focus on low margin high volume sell. Which needs guts to declare after being a public company.

Aggressive volume based growth & focusing majorly on building a trusted loyal pan Indian brand.

Targeting 22-25% growth with 20% margin is really good opportunity.

Financial Highlights:

Over the last 10 years it has make a sales growth of 21% .
EBITDA margin stable at 27% with zero debt, high cash flow, huge cash in bank coupled with operational efficiency and economy of scale in placed.

Risk:
1 Margin Contraction
2 Price disruption
3 Quality of the test in long term
4 Quality and Price of the reagent supplier
5 Any tax impose by govt on Healthcare Service
6 Reach valuation at current price
7 Any down turn in Indian economy

Investment Rationale:

1 Scalable Model
2 Strong Brand in growing segment
3 Strong financials
4 Positive Industry Outlook

[Views might be biased since invested]

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I have used their service which is good and their rates for tests are sometimes cheaper than unorganized or small labs.

DISC: Not invested till now.

Yes it is. And over the long run it will become more cheaper when the economy of scale will be implemented. If we compare the price with it’s peer Thyrocare then Dr Lal is costly but it has a wide acceptance and strong brand than Thyrocare. So the unorganized market of 48% is easily penetrable with more RPL & CC coming up in next few years. This coupled with 15-17% growth rate of this sun-rising diagnostic sector will give a long term sustainable opportunity. Also this sector story is a secular growth story with no black swan effect hence downside is very limited.

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Thanks for the very well writeup.

My only worry is, when company’s say for sake of growth they are ready to take hit of 6%~7% margin, invariably in most case I think, there will be much more hit and it can affect more than 10%~15% margin, as competitors start doing same and irrationality hits the market.

So, the one question I am curious to know is, what pricing power these companies have? I have used Thyrocare and they now offer 68 tests at just 1000Rs. The prices are dropping! For the sake of the volume and to attract the new market, the company is cutting the price which is a good move definitely as it gets them newer customers. Also, there is additional money one has to spend on marketing which will be useful over the long run.

But with competition among industry players and as well as to compete with the unorganized market, will there be huge destruction in pricing of their services? What happens if company like SRL, Thyrocare suddenly starts saying 500Rs I can give the same service what Dr. Lal Path lab gives?

How to find if operationally Dr.Lal Path is more efficient than others, so in long run, these guys will do much better!

Disc: Have a tracking position in Thyrocare

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Hi Prash,

Very good question raised. Let me categorize and clarify your question.

  1. Margin Contraction more than 6-7% :- Dr Lal major business is B2C and the margin hit they are taking is due to their growth target of B2B business where they are making tie-ups with different hospitals to manage their pathology which is mainly a low margin one. But as I have already said it is their brand value which is having more acceptance than it’s peers so their is no chance of price erosion for their existing tests rather they are venturing in to high margin[45-50%] and high growth[25-27%] area of preventive health care and wellness where Thyrocare is a established brand with their Arogyam[52% of their revenue ] which will definitely give them the downside protection.

  2. Other players price disruption :- Thyrocare just made a price disruption before 2 years and I do not see any chance of any more price disruption by them before 8 years or so[Also Dr Velumani said the same thing]. SLR is mainly operating with the Medical network of Fortis so they will not need to make a price disruption . Moreover the price disruption depends mainly on the reagent cost and if you go through the balance sheet of those company Dr Lal enjoys more bargaining power than Thyrocare and SLR. Hence I guess it will have a safe haven regarding the Price of their product.

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A good read article on Dr Lal Path Lab and their expansion plan.

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Q3FY17 con-call highlights Quarter

Demonetisation: Impacted quarter performance due to high dependency on physical cash and slowdown faced by hospitals. Testing decreased across the board, no specific kind of testing was hit. Eastern India faced higher impact followed by NCR. Proportion of cash transactions declined from 55% to 35% due to demonetisation. Gradual recovery has started post demonetisation, and the company expects recovery in 2-3 months. •Revenue growth – 10% (compared to 20% earlier).
•Volume growth stood at - 5%, from walk-ins – 1-2%, from collection centres it was higher than company level.
•No price increase taken during the quarter. Last price increase was taken in June 2016.

Strategy and Guidance

•Focus will be on maintaining a lean cost structure, as taking price hikes will be challenging in competitive landscape •Drivers to reduce costs: Concentrate testing at fewer labs, automate front end processes and improve productivity, and negotiate for reagents.
•Over next 5 years, expects to be a pan-India player driven by M&A, but organic growth beyond core regions appears difficult to come by.
•Expects margins to stablise at 25% (26.5% currently), as it continues to invest in labs, marketing initiatives and employee base.

Others

•Pre- demonetisation total volume growth stood at 15%, same geography volume growth was 10%, new at 5%.
•Radiology currently contributes under 5% of revenue.
•Vendor profile – Has wide range of vendors, dependence on single vendor is not significant.
•At net level, not much difference in margins from institutional clients and walk-ins.

Industry

•High level of PE backed deals will increase competitive intensity, enable large regional players to emerge, improve quality of tests and bring standardisation for the whole sector.
•Expects regional consolidation and M&A activities in industry in next 5 years.
•Believes NABL accreditation is a right step, but the regulatory mechanism in the form of clinical establishment law needs to be implemented first.
•SC has pointed that unorganised sector has players who are not qualified to run their labs.

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http://www.franchiseindia.com/content/How-to-make-wealthy-returns-in-diagnostics-sector.648

I feel diagnostic testing is going to become commodity business in years to come. It’s really difficult to differentiate between one test lab vs another one except on price. In past 2-3 years, I have seen lots of path labs springing up all corners of the city which I live in. All of them has some kind of tie up with Doctors to get them customer on % basis. So its “dog eat dog” world . In long term I expect the price premium paid by the market to go down.

Disclosure - No holding and no plans for the future

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Well not entirely wrong but couple of points to mention:-

  1. Since the main raw material reagent most of the companies have to import hence the cost of test and margin will depend on the price volatility of the reagent and in this particular case companies like Dr. Lal, SRL, Metropolis have a moat since they have tie up with the vendors to procure it at the cheapest cost hence there raw material cost is at 20% around where as othe Mom and Pop shops having it at leat at 30%.
  2. Brand will play a definite role in this segment and Dr Lal is a well recognized brand in this segment.
  3. Inorganic growth will play a key role in growth like Metropolis just acquire Sanjeevani. So I can clearly see a industrial consolidation in this segment.
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Recent decision of Delhi government could be bad news for companies like Thyrocare and Dr. Lal Path labs

Good discussion on this subject can be read here

Disruptive technology

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Though people are very bullish on Path lab businesses I found there quite commodity in nature as mentioned by some other members as well. Another point is lab testing is poised for huge disruption due to availablity of huge computing power through smartphone and cloud processing. Last but not least high ROE will keep attracting more players and its not a kind of business which someone smart with enough money not destroy (read copy business idea). It does not have qualities of business which will compound your money.

https://www.theranos.com

Theranos has turned out to be fraud and the founder Elizabeth Holmes is behind bars AFAIK

Read the below fascinating article

But still, the business is a commodity in nature. But even in the commodity business, there are few who can score well and be the better than others by building a better brand.

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no one in street thinking of technological disruptions, I know people who do PE / startup investing all existed these diagnostic business via IPO think world is changing. They are invested in these new age diagnostic startups which are making things by which your smartphone will be able to give you your blood report by using cheap gadgets shown in the video above.
the startups are working on technology to bring pathlab into your home, Its foolish to see reports made by analysts have no mention of it. they have happily taken 20% growth for 20 years and were justifying 80 PE for the stock.

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The company has been granting large amounts of stock options to the CEO, Mr. Prakash Manchanda. He converts the vested options into shares and sells them in market. As per the Annual Reports of FY16 and FY17, the CEO has received Rs. 26 Cr and Rs. 30 Cr. in the form of employee share based compensation. It has been mentioned in the Annual Report for FY17 that the share based compensation represents difference between the exercise price of options exercised during the year and the fair value of shares issued as on the date of exercise. The share based compensation received by Mr. Manchanda in FY17 was around 20% of PAT for FY17.

Undoubtedly, the CEO has been performing well and he must have played a significant role in the growth of the company. But shouldn’t this be considered a big negative about the CEO’s intentions and blatant robbing-off shareholder’s money?

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The biggest issue with Thyrocare or Dr. Lal is the impending doom of government regulations. There is a lot of talk of capping diagnostics prices in the 128 odd tests listed in WHO. Im not sure what % of their total revenues come from these tests but its a negative nontheless. I just cant get myself to pay for 45 times trailing earnings under these circumstances. If this does end up coming through, the stock is likely to get de rated very quickly and all those people who talk of this being a steady compounder are likely to start talking about the reducing/stagnating revenue/test implying the commodity nature of the business!

The source of returns of this business is the operating leverage. Incremental cost of doing an additional test (cost of reagents, chemicals, etc.) is only 65Rs/test whereas they charge approximately Rs. 300/test. The cost per test has not risen more than 2-3% per year and hence all the incremental sales have dropped to the bottom line. Sample collection is actually the biggest cost.

Source:

Source of figures is the annual report

Disc: Not invested

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