Lab company results flag high valuations
Shares of diagnostic testing service providers Thyrocare Technologies Ltd and Dr. Lal PathLabs Ltd are in reverse gear. Even as benchmark indices are scaling new highs, these stocks are down substantially from their 2017 peaks. The stocks fell as slower revenue growth (see chart) and rising competition made investors wary.
To be sure, growth momentum has not completely dropped off. Dr. Lal PathLabs is preparing to launch a reference regional lab in Kolkata, which should boost business in the region. It expects second half revenue growth to be strong. “Management guided for 14-15% revenue growth for FY18F. This compares to 8.7% growth recorded in H1FY18. The guidance implies growth of 20-22% in 2HFY18F,” Nomura said in a note on Dr. Lal PathLabs. Thyrocare also expects the second half revenue growth to improve.
But that has done little to lift their shares. Competition especially in the business-to-business (B2B) segment of the diagnostic services, a large business area for both companies, remains intense. New companies, in their rush to gain customers and volumes, are indiscriminately reducing prices, exerting pressure on established companies like Thyrocare and Dr. Lal PathLabs. “All the guys who are coming in know only one thing, the only way to get traction. So the investors put in money and they don’t tell them what is the turnover they want, they tell them what is the number of specimens they want. So that gives the investee a freedom to experiment, because the investor has told him bluntly don’t worry about profit I want you to get volume,” A. Velumani, chief executive officer of Thyrocare Technologies told analysts after the September quarter results. In the first half of the fiscal year, 69% of the company’s revenue came from the B2B segment.
Of course, the management commentaries do not indicate any further deterioration in the market situation. Also, they are trying to mitigate the pressure through cost rationalization and expansion into wellness or preventive health check-ups (B2C segment) which is expanding at a faster rate. But this segment is also seeing new competition. Further, relatively large exposure to B2B segment means this segment continues to have a bearing on the companies’ near-term growth prospects.
These challenges, seen in conjunction with high valuations—both stocks are trading at about 30 times one-year forward earnings multiple—are making some analysts wary of the sector. “While we believe structural trends remain favourable, the near-term outlook is likely to be driven by prevailing environment in the B2B segment and ramp-up of Kolkata reference lab,” Kotak Institutional Equities Research said in a note on Dr. Lal Pathlabs. “Lal PathLabs is trading at 35 times FY2019E EPS (earnings per share), with limited room for upside,” it added.