Krsnaa Diagnostics - what is the diagnosis?

I’m not a fan of IPOs at all, and most of them last year have priced in years of growth. Keeping this in mind, I initially approached Krsnaa with a negative bias. This thread is a story of why I changed my mind, and why I believe Krsnaa deserves the attention of investors on the forum.

Summary of Investment Opportunity

  1. A company that has scaled tremendously in the last decade.

  2. A bet on rural healthcare, built out of a differentiated business model.

  3. A valuation gap between peers, and operating leverage to come.

  4. Least exposure to one off covid revenues in the industry (covered in the thread)

Krsnaa’s Scale and Model

This is a company that has over 1800 diagnostic centers in India, spread across 14 states. What surprises me the most, is that it’s only ten years old. Founded in 2011, they managed to scale operations from two radiology centers in 2011 to over 1800 today.

How did they do this? While competitors worked to build standalone diagnostic centers in tier 1 cities, Krsnaa focused on winning tenders for the government’s private-public partnerships.

The second thing to note alongside scale, is that Krsnaa is the one of the cheapest providers of diagnostic tests:

The Public Private Partnership Model

Vijaya Diagnostics’ DRHP tells us that urban diagnostic centers account for 76% of India’s diagnostic revenue, while rural centers form 24% of the revenue. The reasons are fairly intuitive:

  • Mostly government hospitals in rural areas that have basic facilities.

  • Rural patients often travel to tier 1/2 cities in order to take a diagnostic test.

The government, in a bid to solve this problem, set up the PPP model. Here, they invite private players to set up the same urban MRI/X-ray machines in rural government hospitals. To make the offer attractive, they provide free space in the hospital, and utilities like water/electricity varying contract to contract. The private companies need to set up the room to standards, and bear the cost of equipment and staff.

1. Features of a PPP tender

  • Tenders are published on the government website, there is a minimum threshold of size and experience companies need to have in order to be eligible.

  • After inviting bids and a technical evaluation, the lowest cost offer for prices of various radiology / pathology tests wins the bid.

  • Prices are locked in, winning bids cannot change the prices of tests offered at will.

  • The tender is awarded for 7-10 years.

Now, Krsnaa has won 80% of the tenders they’ve bid for. They’ve explained that this is usually because smaller regional players offer to take up the tender for one or two hospitals, they sweep entire states at a time. Secondly, they’re the lowest cost offer on the table.

1.1 If Krsnaa don’t control how much they charge for tests, how are they competitive?

This is a concern I had while reading through the PPP tender documents. If Krsnaa wins a tender by setting test costs at 2000 rupees, it cannot increase prices above this should raw material costs go up, staff costs, etc. This takes away from their ability to respond to changing macro cycles.

However, PPP tenders have annual price increases of 3-7% written in the contract. Is this too little? Krsnaa’s management answers a definite no, and argues that it’s industry leading:

1.2 How is Krsnaa is able to price tests this low and still deliver high EBITDA margins?

Rural centers are often difficult areas to send qualified doctors / staff to, and this has been a barrier for a long time. Krsnaa has got around this by having all of their doctors in Pune, and having rural centers send the scans through the internet to their hub.

Secondly, they have a relationship with their equipment suppliers (Wipro GE and Fujifilm), and are able to get these at a discount to peers. This allows them to place competitive bids in the PPP tenders, and saving on rent improves the margins.

Key takeaway: A large part of Krsnaa’s revenues is secured in ten year contracts under the PPP model.

Investment Pointer 1: Krsnaa stands to benefit from increasing spend by the government on rural healthcare

Market opportunity on the PPP model alone is estimated to be 13,500 Cr. by 2023, growing at around 15% CAGR from FY21 numbers. Krsnaa’s current revenues are 400 Cr. in FY21, which showcases the opportunity size.

Government is cognizant of this gap and is trying to bridge it via the PPP model.

Peers and Business Aspects

According to Krsnaa’s DRHP, it has grown at 47%, mostly on the back of adding hundreds of new centers.


  • While Covid was a one off for test providers, the core business has been outperforming in H1FY22.


Outlook and Valuation

Investment Pointer 2: Significant operating leverage may play out

Krsnaa tells us that they have a huge headroom for tests:

image

  • With less than 40% utilisation (industry standard is 60-70%), Krsnaa stands to benefit from increased uptick of patients taking their tests. Management expects to improve this every quarter going forward.

  • Krsnaa has recently been awarded a tender in Punjab for a number of centers. This is currently live in Q4FY22 and will add on to the capacity available.

  • Management has alluded to FY23 sales being between 600-700 Cr. This clocks in to around 25-30% topline growth. With better utilisation of centers, margins should steadily improve, aided by the annual price increases.

This means that Krsnaa is between 3-3.54x FY23 sales. Peers are trading at obscenely rich valuations for similar margin profiles.

Company Price to FY21 Sales
Dr. Lal Pathlabs 14.87
Metropolis 12.8
Vijaya Diagnostic 13.81
Krsnaa 5.37

Risks

  1. The lack of flexibility to increase test costs may hurt them in a high inflation environment.
  2. Capacity utilisation may never hit 60%.
  3. Receivable days are between 60-90 to get money from the government. They may not pay up
    • Counter argument: they have not had a single bad debt/missed payment in the last decade.
  4. Rural India may continue to prefer going to urban centers over government hospitals.
  5. Diagnostic companies may see a de-rating post covid, and evaluating fair valuations may be tricky.

To do:

  1. Detailed information on management.
  2. Information on the landscape between radiology and pathology.
  3. Information on the convertible preference shares that have hit FY20 and squared off in FY21.

Disclosure: Invested in Krsnaa Diagnostics. All views may be biased. I am not a SEBI registered advisor. Please do your own due dilligence.

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These are extracts obtained from a KPMG report regarding the diagnostics industry. On the surface, the company seems to be doing everything correctly, but the issue remains that how long can they can continue scaling their business and how much their dependence on the government might potentially harm them.

Link to the report : https://assets.kpmg/content/dam/kpmg/xx/pdf/2018/07/the-healthcare-diagnostics-value-game.pdf

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Thank you so much @Chins for providing such a detailed and informative piece on Krsnaa Diagnostics. Two things that I feel are important for this company are as follows:

a) Cost efficiencies: The company is one of the single largest equipment owners of 62 CT machines and 26 MRI machines (as of Mar’21) in India and is also procuring equipment in double digits for a single order. Its scale and procurement size promotes competitive bargaining with vendors; usually, its procurement prices are 10- 15% lower than peers . As KRSNAA owns multiple types of equipment, its maintenance charges are almost 20-25% lower than its competitors, which brings in cost efficiencies.

b)Government Support: Government support and incentives are something that only PPP players like KRSNA receive, for example, Government support will aid in the development of hospitals and healthcare centres under public-private partnership (“PPP”) this will create an investment opportunity of ₹150-200 billion under the social-infrastructure space.

To boost private investment in social infrastructure, the government in the past has announced an outlay of ₹81 billion with viability-gap funding (“VGF”) limits enhanced from 20% to 30% of project cost for both the Central and state governments to attract private investments in the social infrastructure space.)

PPP model allows leveraging existing health infrastructure and upgrading their services
• Enhances penetration of quality services at remote and underpenetrated locations
• Government-led diagnostic facilities offer quality services at costs that are nearly 50-60% lower compared with private facilities
• The Indian diagnostic industry has grown consistently over the past three fiscals and is projected to grow at a CAGR of approximately 15% between fiscals 2021 and 2023.

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How PPP work ? It gets tendered after every 7-8 years ? and if they lose in the tender will they lose the Equipment’s also or will they get to keep the it ? Company earns abnormal return on capital due to everything is rented / owned with Gov under PP.

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Taking this point by point.

  • Tenders are given for a duration between 7-10 years. Most of Krsnaa’s contracts are for the full ten years.

  • Tenders usually include a renewal clause based on performance and mutual agreement between government and provider. As machines/rooms are set up and on site, it’s convenient for governments to extend, and not repeat the entire technical bidding procedure.

  • Since Krsnaa won a bulk of these tenders after 2018, renewal will not be discussed until 2025-2028. Krsnaa’s management was asked about renewals in the pre IPO call, and they’ve said that it’s too early to think about renewals, and they aren’t worried given the renewal clause.

  • On the flip side, Krsnaa has termination clauses to end the relationship should the government not pay. No such event has happened to date.

  • Equipment belongs to Krsnaa, and has a life of 15 years. They also have comprehensive maintenance contracts with OEMs (manufacturers cover cost of broken parts), and are required to have third party inspections done. Based on this, it’s likely that whatever tenders were awarded in 2018 will only need machines to be replaced after 2030.

  • On abnormal RoCE, if you’re looking at numbers from Screener.in, there are a few discrepancies:

    • RoCE is not >100%, pre-tax RoCE/RoIC are currently 15-20%, and are expected to rise with better capacity utilisation.
    • Screener shows the PE as ~13. This is incorrect due to an issue of compulsory convertible preference shares (affected FY20 and FY21, is dealt with going forward). Adjusted FY21 PE is around 100.

I’m linking an actual PPP tender document, feel free to go through it to see the requirements and clauses typically present in these contracts. These do vary from tender to tender, but should give you a general idea.

eTender OSMCL PET CT Services in PPP upload.pdf (1.4 MB)

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Results have come in

So I think the company is on track to do around 440 crs this year FY22E which is around 10% growth YoY.

Revenue was flattish 106 cr QoQ maybe slight degrowth QoQ in Q3FY2022- and margin pressure is there will have to jump on the concall to know what led to this as the EBITDA margins have dropped to 26% this quarter that’s around 300 bps decline QoQ

Stock will take a beating in the next trading session.

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@chins has covered key points well, some additional points

Govt projects related issues/perception

  • Govt tender usually has Receivables problem - Mgmt has clearly called out no issues so far and CFO has been great, infact they have also indicated that cash flow will take care of next 3-4 year growth plans( 100 cr/yr ftom FY 23) - more details in Q2 concall
  • Payment security - per mgmt govt is setting up specific purpode escrow accounts ( case of all new contracts like Punjab etc) to ensure payments are never stressed/redirected due to other priorities

Margin sustainability of 30% - mgmt called out multiple levers -

  • low per employee cost ( lab staff at small cities have fraction of cost+ outsourcing mix).
  • No overheads such as facilities/ infra/ marketing etc - margins flows through straight.
  • Even after quite low test prices, margins are similar/better to peers give cost base is much smaller due to above reasons, infact as utilization picks up it can improve( though partially offset by new state tender wins)

Growth and tender win ratio

  • They have delivered industry leading growth over many years, infact no PAN India level player competition makes their win ratio very high in PPP space. Though given high margins it does attract regional players.
  • Regional players can’t compete effectively because of Krsnaa volume and scale based sourcing advantage ( e.g. MRI/CT scan supplies them at 15%+ discount thus creating a scale moat)
  • Built in price escalation + utilization increase for assets as they mature help them manage margins

Post listing Stock has taken a beating and now seem to be building a base per charts, covid tailwinds are behind and all of sector has corrected to saner levels.

Both Q2 concall and Q2 Deck is a good resource for those interested, Q3 call will be good opportunity to interact and understand progress on new wins/utilization/per test realization etc.

Press release on Q3

Invested post Q2 call and plan to add as execution scales

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Q3 results are intact and some blogs mentioned Q3 FY,22 YOY posted loss which can be ignored, as the difference we see in year on year comparison may n’t work as they made balance sheet adjustment during last year prior to IPO inline, and in fact profits are up from Q2 quarter with the revenue inline. Ideally, we should n’t compare the YOY balance sheet for this specific financial year trend and we only need to compare between QOQ for Krsnaa for this year…

and the beauty of PPP is the key for Krsnaa growth and it is definite that it gets the business irrespective to weather, and the margins are very much higher as it doesn’t incur rentals etc…

Krsnaa inaugurated part of its IPO commitments diagnostic centers starting from December and have a pipeline built to operate 29 CTs and 6+ MRI during Q4. This count of new addition is huge and definitely improves the top line and bottom line going further.

Current : 65 CTs + 30 MRI machines
IPO Proceedings : 29 CTs + 8 MRI ( by Q4 FY22 )
Total = 94 CTs + 38 MRI

Disc: Invested

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There’s a deeper story underlying the numbers. At first glance, we see that the revenues are up ~10%, this looks disappointing, barely over the industry growth. However, a further inspection of Krsnaa’s underlying business reveals something more:

  • In FY21, Covid revenues were a one off for the company. In 9MFY21, they delivered 134 Cr. of Covid revenues, and this was ~45% of the pie. In FY22, after price ceilings for tests and general competition, Covid revenues have fallen to 39 Cr., only ~10% of the overall revenue.

  • What this should immediately tell us is the growth of non covid business must have been immense for the company to have delivered positive YoY delta, despite the huge drop in covid revenue (134 → 39). Indeed, this is true:

  • From here on out, since Covid revenues formed ~1% of Q3’s pie, all focus should be on the core business, as 79% and 96% YoY growth is no small feat.

  • Gross margins have improved slightly QoQ even if EBITDA margins contracted, we’ll learn more in the concall.

  • Other KPI, number of tests conducted and number of patients have significantly improved YoY:


D: Invested, biased.

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We had severe COVID in Q1 and Q2 of FY 2022; You may argue COVID tests price have crashed but the CT Chest was at its peak (no one has reduced CT price). Moreover, hospitals were also fully occupied during that period which suggest Non-COVID blood investigations will also be high.

I am unable to match ground reality with their numbers

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Government of Uttar Pradesh has awarded a Tender for providing CT Scan Services in the 8 District
Hospitals in the State of Uttar Pradesh to the Company.

https://www.bseindia.com/xml-data/corpfiling/AttachLive/b4bf7b8f-d543-49b3-8645-a59d0398a665.pdf

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Good part about its contracts are that all of them are for long term. This one too is for a minimum of 7 years, with a possible 3 year extension. Given its small market cap of 2000 crores, do you guys think it is nicely positioned for exponential growth in the next 1-3 years?

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Existing investors picked additional stake via market purchase

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Sector scan:

Company Q3FY22 Topline Q3FY21 Topline EBITDA Margins Q3FY22 Margins Q3FY21 Covid Revenues Q3FY22 Covid Revenues Q3FY21
Dr. Lal Pathlabs 497 452 22% (28% excluding one off) 31% 11.87% 24.33%
Metropolis 293 275 26% 32% 17% 19%
Krsnaa 106 98 29% 19% 1.1% 19.5%
Vijaya 111 100 43% 46% 7.8% 14.4%
Thyrocare 117 138 31% 36% 5.6% 19.68%

KPI:

Company Q3FY22 Tests Conducted Q3FY21 Tests Conducted Q3FY22 Number of Patients Q3FY21 Number of Patients
Dr. Lal Pathlabs 16.9 million 13.5 million 6.6 million 5.5 million
Metropolis 6.3 million 5.1 million 3.3 million 2.7 million
Krsnaa 4.68 million 3.07 million 1.97 million 1.42 million
Vijaya 2.32 million 1.91 million 0.85 million 0.68 million
Thyrocare 4.06 million 4.7 million 3 million -
  • Currently, Vijaya and Thyrocare are market leaders on margins.

  • All players have suffered from covid test revenues dropping off a cliff. Krsnaa has the least exposure presently with 1% of their revenues coming from covid. Metropolis has the most to lose, followed by Dr. Lal.

  • FY23 could see Krsnaa overtake/close in on Metropolis’ tests taken / footfall.

My takeaways from the concall:

  • Krsnaa’s management plans to double all existing capacity, which is already at comically low capactiy utilisation. This means we won’t see their true asset turns/RoCE numbers until they stop expanding. I didn’t get a chance to ask which their best performing center is - I wanted to know if they’ve been successful in hitting 70%+ utilisation, this is needed to know if they can replicate this in rural centers.

  • Crucial - while they’re present in PPP tenders, they are agnostic to clients that walk in. If walk ins are referred by governments, they get free treatment. However in metros, 50% of the footfall are private, even HNI patients. Governments don’t discriminate between private/public walk ins. Therefore, the PPP centers can be thought of being akin to standalone diagnostic centers with free rent, and disruptive prices.

  • There have been instances in the past where other players outbid them in tenders, but very quickly realised they could not compete, and the bid came up for re-tender, and Krsnaa picked these tenders up.

  • Despite going from 2 centers → 1800, tip of the iceberg for PPP model. There are 750 districts, they’re only in 76. 26,000 public hospitals and Krsnaa’s present only in a handful.

  • Scope for leveraging their network gained through PPP - B2C product offerings and more partnerships with private hospitals. Goals are for revenues to be a 50/50 split between PPP and private. More details in Q1FY23.


@Dev_S this repurchase by Phi Capital is bizarre, I don’t think I’ve seen many instances of this. Phi Capital offloaded 1.6 million shares through an OFS during the IPO, and have now bought back nearly 10% of what they sold (purchases in Jan + Feb).


PS: I had earlier flagged that CFO pay was strangely low - 3.7 lakhs in FY21. I deleted that post as I found the answer, and realised I had posted incorrectly - CFO was appointed late in FY21, and worked for only 1-2 months with the company. Therefore 3.7 lakhs looks low for FY21, but annualising the rate makes it much more reasonable.

Disclosure - Invested, biased

Edit: added in Thyrocare for comparison

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@Chins yes it seems Phi sees value at current price( which is nice 35% discount to OFS)+ sending a message to protect invested stake valuations :slight_smile:

Some additional points from Q2 to Q3 flow of events -

  • Punjab, Himachal wins and Q4 center opening per plans ( some done, some more in Qtr) - mgmt is walking the talk
  • Cashflow driven growth - historical EBDITA to CFO ratio is good, current cash and future yearly cashflow to take care of next phases of expansion per mgmt ( key monitorable as utilization wouldn’t be very high and new centers will require continuous investments)
  • Recent wins announced in MH, UP etc inline with high win ratios, center growth doesn’t seem to be an issue
  • Thyrocare has apparently in past won some govt biz in MH/Mumbai post pharmeasy acquisition ( need to check if they are getting into PPP or it was covid times only)
  • B2C pilots are being experimented before scaling, this could also be the reason to improve utilization of current stable centers( why bother if running at high capacities and prices stay same) - infact at bidding itself expect them to be conservative in capacity planning to minimize risk( need to better understand downside protection in tenders)
  • 650 cr+ revenue and similar margin profile as guidance in FY23. At 30% EBDITA they are at 10X forward EBDITA. Significant room for upside if they can deliver good Q4 and ramp up of new centers is healthy without much dent in margins.( Q3 is seasonally weak and it’s now core biz base only)

To better understand

  • How do they decide which bids to prioritize? They never had any Receivables issues so far is reassuring.

  • Biz model characteristics and margin levers of each sub business, relative importance at consol

  1. PPP govt tenders based centers
  2. Private hospitals
  3. Pune Tele health center

Sector developments

  • Entire sector has got derated post covid tapering , or more realistic expectations are being built now
  • Diagnostic B2C sector is quite competitive where leaders like lalpath are also betting on volume growth lever than price( prices are same for many years ), consolidation is already visible - through Krsnaa is immune to some extent with PPP model focus but this factor may keep whole sector under pressure
  • Competetitive landscape in PPP tenders ( esp PAN India players with scale)

INVESTED and adding in dips.

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Thyrocare results are out , looking bad but interest was to see core biz non covid numbers.

At core biz Throcare and Krsnaa both are similar numbers - 100 cr+ qtrly revenue, 30%+EBDITA

For similar performance, At current valuations Thyrocare @ 5000cr mkt cap is 2.5 times Krsnaa valuations. @ 2000 cr

  • Another interesting call out was Thyrocare getting out of B2G biz, looks like Krsnaa doesn’t have any serious PAN India competition, we can say this not only strengthen their win ratios but also provides ability to bid for higher quality bids in absence of serious competition

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Given entire Diagnostics sector is under stress /derating ( after insane valuations during covid times) , it was interesting to see how key players performed in lieu of subdued performance of Q3, here is what it looks like from Jan 1st. Krsnaa has outperformed in short term.

To see overall since krsnaa listing, here is the view and obviously Krsnaa is at near bottom

Summary - while Krsnaa has been beaten down post IPO( which came in midst of Corona wave), in line with all other pricey IPOs. Near term outperformance from peers and valuations provide margin of safety comfort. Bigger question would be that once market fancy goes away from a sector, takes time to come back - as one can see almost no participation in yesterday’s bounceback.

Two ways to look at it - opportunity cost till next Qtr results are out and mkt makes up its own mind to recognize performance OR right time to start nibbling with patience when no one is interested and structural story is intact.

Sideways mkt followed by Raging bull mkt does require expectations reset on one’s momentum expectations as well :smile:

Invested

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This is significant, Phi Capital Trust – Phi Capital Growth Fund – 1, which is invested since pre-ipo is giving a vote of confidence by picking 0.5% stake between Dec end - till now from open market. Their stake has gone from 15.19 to 15.69%

Disclosure : Invested in last 15 days.

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  • Current : 65 CTs + 30 MRI machines

  • IPO Proceedings : 29 CTs + 8 MRI ( by Q4 FY22 )

  • with the new winnings on board tentatively - [ 8 District hospitals in UT, 1 in Chandigarh ]

  • 8 CTs, 1 MRI - the company to ensure the commencement of operation and issuance of notice to proceed within a period of 120 days (approx. 4 months)

  • IPO proceedings - expected to complete this quarter and revenues might shoot up from Q1FY23

  • old total + ipo proceedings + new winnings = 65 CTs + 30 MRI machines + 29 CTs + 8 MRI + 8 CTs + 1 MRI

  • new total = 102 CTs + 39 MRI


Disc: Invested

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Quick recap Q2 vs Q3 to see if mgmt is walking the talk in consecutive Qtrs, while new centers anc win going well overall, numbers are yet to deliver.

Some numbers and key monitorable

*Test realization
Q2 22 numbers

Realization is down in Q3 sequentially - explanation below

Nothing major but some stability/growth needed in Realization, let’s see trend in Q4.

  • 2/3 years out ambitions Pre IPO - 150+ CT & 50+ MRI , pre Ipo they were at 65 CT and 30 MRI

Aspirational numbers but seemed more like a rounded off figure than well thought out strategy. Again too early to judge, recent wins are promising.

Now in Q3 same EBDITA guidance view changes for little subdued for short term

This could be a spoiler if margins fall substantially, positive if no major dent.

Same guidance becomes 150 Cr in Q3

Idea of above was to see if management is walking the talk and how much we should rely on guidance, while nothing major stands out, but on smaller bits it is safer to take mgmt guidance with a pinch of salt( build buffer), also bit risky in terms of loose comments on numbers which may hit with negative surprises ( rather under commit and over deliver) - which is imp to build credibility given recent post IPO story. Too early to judge but so far mixed signals in communication.

Additional points

  • Significant valuations discount to peers, IPO performance leaving a poor taste as well
  • Unable to find much on Mr Rajendra mutha - key promoter, entire media coverage is by Yash
  • PHI regular buy is reassuring as well as confusing
  • No buying from promoter group yet - even after 40%+ fall - even if symbolic ( that’s what probably Phi is playing)
  • 82%+ in strong hands( promoter + fii+ dii) - many marquee names

Invested but would prefer to see Q4 delivery/ trend reversal before scaling further, stock is bearish on charts - no trend reversal yet( but so are all diagnostic stocks)

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