Thyrocare, Metropolis share price rise shows diagnostic sector valuations over-stretching1 min read . Updated: 27 Aug 2020, 10:08 PM IST
High operating margins of diagnostic chains could come off, due to the high fixed-cost nature of business
Stocks of diagnostic chains are seeing a sharp rebound, even rising over pre-pandemic levels. Thyrocare Technologies Ltd, for instance, has jumped 37% in 2020, while stocks of Dr Lal PathLabs Ltd are up 24% and Metropolis Healthcare Ltd are about 25% higher. Covid-19 cases are increasing, driving demand for testing, but the sharp run-up in the sector leaves little room for upsides.
Agreed, covid-19 testing may have kept the cash registers ringing in the last quarter. However, some of the government’s testing capacities have increased. Hence, business from the government side is expected to reduce. Nonetheless, the flow of patients could continue from in-patients and hospitals, which are expected to make covid-19 testing mandatory, along the lines of HIV or blood sugar tests.
As such, covid-19 anti-body tests could pick up in the coming quarters even after the vaccines are launched. These tests have a higher margin profile, and also play a role in managing covid-19 once the vaccines hit the market.
However, non-covid testing is yet to return to normal levels. Analysts said preventive healthcare and body-checks will slow down as people postpone them for now. Further, with patient flows at hospitals and clinics slowing down, new prescriptions for diagnostic tests are not being generated.
Some geographies, such as the north, where lockdowns are less stringent, are seeing some increase in patient flows. Major cities where strict curbs are in force, such as Mumbai, are not showing much improvement in non-covid testing.
Even so, the high operating margins that diagnostic chains enjoyed could come off considerably in the coming quarters. That’s because of the high fixed-cost nature of the business. In fact, margins shrunk sharply in Q1 due to lower operating leverage. Soaring stock prices are another concern.
“Margins should start to normalize in the fourth quarter onward. People may not be able to postpone testing for long. But stocks are quoting at premium valuations," said Bharat Celly, pharma analyst, Equirus Securities. Given that most of the diagnostic players have reported depressed earnings in Q1, their trailing price-earnings multiples have shot up significantly. In fact, price-earnings multiples for the sector is quite high at 65-90 times.