It's often said that those who can bend with the wind, will weather the storm. The sharp volatility in markets amid Putin's invasion of Ukraine and rising oil prices, has shifted investors’ focus back to fundamentally strong companies that are now priced competitively.
This week, we look at such newly affordable stocks, and also at how Indian businesses are bracing themselves for the post-pandemic world.
In this week’s Analyticks:
- Waning Covid-19 business forces diagnostic companies to look for new sources of growth
- China+1 strategy drives exports jump for agrochem major PI Industries
- Screener: Which stocks are in the PE Buy Zone post the market correction?
Let’s get into it.
Diagnostic labs are changing their strategy post-Covid
Diagnostic companies were in the spotlight for around two years with the pandemic.Covid-19 related testing helped these companies post strong revenues and profits. However, with the end of the pandemic's third wave and falling Covid testing, diagnostic companies are looking at different growth strategies.
Diagnostic labs saw modest YoY revenue growth in Q3FY22, missing Trendylne’s Forecaster Estimates. The overall revenue trend is still upward: Dr Lal Pathlabs’ Q3FY22 revenue rose 9% YoY to Rs 509 crore driven by robust growth in non-Covid revenues while Vijaya Diagnostics’ revenue grew 11% to Rs 114 crore. Only Thyrocare Technologies’ Q3 revenue fell 19% YoY to Rs 118.8 crore due to a reduction in Covid testing volume from government contracts.
In terms of non-Covid revenue growth, Dr Lal Pathlabs leads the pack with an increase of 28% YoY to Rs 438 crore. Metropolis Healthreported a modest 7% growth to Rs 243 crore in non-Covid revenue in Q3 due to lesser revenues from government contracts.
However, the net profit numbers across the sector tell a different story. While Metropolis Healthcare’s revenue in Q3FY22 increased by 6% YoY to Rs 295.7 crore, its net profit fell 30% to Rs 41 crore. This fall in revenue is not limited to Metropolis Healthcare alone, Dr Lal Pathlabs’ net profit fell 39% YoY to Rs 57.3 crores as well. Only Vijaya Diagnostics managed to report a marginal increase in net profit by 2% to Rs 25.3 crore.
The operating profit margin of all four companies decreased YoY in Q3FY22. While Dr Lal Pathlabs operating margin shrank by 870 bps YoY to 22%, Metropolis Healthcare’s margin fell 580 bps to 31.53%. Comparatively, Vijaya Diagnostics performed better with a decrease of 300 bps in operating profit margin YoY to 43.6%. The revenue per patient and per test fell for these diagnostic labs. For Metropolis Healthcare, revenue per patient fell 13% YoY to Rs 898, and revenue per test decreased by 14% to Rs 462.
There are a lot of moving parts responsible for this fall in profit margins in the sector. A drastic decrease in the operating profit margin from Covid revenues is a major contributor. According to Dr Lal Pathlabs’ management, the price of a Covid test for international passengers at Mumbai airport fell 44% to Rs 1,975 in Q3. The introduction of price ceilings by governments on Covid tests played a big part in this. In addition, the acquisitions by the diagnostics company pulled down overall operating profit margins as well.
However, when we look at the bigger picture in terms of annual revenue growth, the growth story for the diagnostic sector remains intact. The diagnostic industry is expected to grow at a CAGR of 12.1% over FY21-FY23E.
Only 15-20% of the overall market share of the diagnostics business is captured by listed companies. Given this fact, acquisitions of established private diagnostic labs has been the primary growth strategy for the top companies in this sector. While Dr Lal Pathlabs acquired Suburban diagnostics in Mumbai in Q3, Metropolis Healthcare acquired HiTech labs, which has a strong presence in South India.
Interestingly, both acquired companies have lower operating margins, resulting in a lowering of the overall profit margin. However, the increase in the number of patients is what these acquisitions are aiming for. The number of patients increased by 21% to 66 lakh and 22% to 33 lakh for Dr Lal Pathlabs and Metropolis Healthcare, respectively. The strategy of these companies is to leverage this increase in patients and top line growth, while normalising profit margins by offering a wider diagnostic test menu to new patients.
However, revenues can come under pressure with large healthcare service providers expanding aggressively into integrated digitised healthcare services. All these developments are happening after phenomenal Covid-led growth, as diagnostic companies try to keep flying high post pandemic.
Rising input costs spoil the party (a little) for PI Industries
The rise in input costs hurt almost all sectors, especially manufacturing companies. From auto to chemicals and coal, rising cost is a shared thorn in everyone's side. The story with PI Industries is no different.
Total expenses for PI Industries increased 18.8% YoY to Rs 1,123.4 crore in Q3FY22. Although the company tried to pass this on by increasing their product prices, the management says that the full effect will be visible from Q4FY22.
Net profit rose 14% YoY to Rs 222.6 crore. Analysts at ICICI Direct believe this was because of lower taxes in Q3FY21. Revenues grew 17% YoY to Rs 1,356 crore.
Growth in revenue is mainly because of growth in the CSM (custom synthesis and manufacturing) segment. This segment recorded a growth of 19% YoY to Rs 1,076 crore in Q3FY22.
EBITDA grows but margins take a hit
The rise in costs hurt EBITDA margins, which fell 210 bps YoY to 22% in Q3FY22. It also affected gross margins which fell 49 bps YoY to 46%. Cost of materials rose 13.8% YoY to Rs 671.3 crore (however this fell sequentially by 12.5% in Q3FY22). The sequential drop suggests that the company is tackling the problem of rising input costs.
EBITDA is up 8% YoY to Rs 297 crore. A favourable product mix helped absolute EBITDA grow in Q3FY22. However, the increase is very subtle as overhead costs surged by 24% YoY to Rs 333 crore. The rise in overhead cost is because of a spike in fuel prices, shipping costs, and expenses related to strategic initiatives.
Exports rise because of the China+1 strategy
PI Industries’ exports rose 19% YoY to Rs 1,076 crore in comparison to 8% YoY (Rs 280 crore) growth in the domestic market. This is because China is losing out on market share in the global chemicals sector. China had the lion’s share in this market for almost three decades until its unsustainable environmental practices led to the closure of most of its chemical manufacturing hubs.
As Chinese manufacturing tries to comply with new environmental rules, they are facing high operational and capital costs resulting in production cuts and supply-chain disruptions. This has caused most global companies to shift their procurement away from China and choose other alternatives, including India. This strategy is commonly known as the ‘China+1 strategy’. It is one of the main drivers for rising Indian chemical exports, and PI Industries has cashed in well on it.
Brokerages enthused by PI Industries prospects
Brokerages like Chola Wealth, Geojit BNP Paribas, and ICICI Securities are positive on the company with ‘Buy’ calls for this stock. They expect a strong order backlog in the CSM (custom synthesis and manufacturing) segment to drive growth as most of PI's revenues came from this segment in Q3FY22. Currently, the order book of the company stands at Rs 140 crore. The company is also diversifying into the pharma segment to improve its product mix and presence in the market.
PI Industries' is already working on scaling up its biochemical processes for both pharma and non-agrochemical segments in Q4FY22 and Q1FY23. The company expects 15-20% of revenues to come in from the non-agrichemical space for FY23-25. For now, its strategies put it on track to clock total revenue growth of 15% for FY22.
Screener:Stocks in PE buy zone with reasonable durability and quarterly growth rates
While the Nifty 50 index was resilient over the past month, BSE Small Cap and Nifty MidCap 100 indices lost nearly 10% and 7%, respectively.
This screener (subscriber) shows a list of stocks that are now trading in the PE Buy Zone, but also saw decent topline and bottomline growth in an otherwise difficult Q3FY22. These stocks are also on analysts’ radar given their robust business prospects.
Among 27 companies, heavyweights like Hindustan Unilever, Axis Bank, ONGC, Hindalco Industries, and Indian Oil Corp are currently trading in the ‘Buy Zone’. Given that Q3FY22 was a weak one for the FMCG sector, HUL continues to stay resilient in the face of inflationary cost pressures. Oil companies’ Q3 sales realisations got a boost owing to a nearly 70% YoY rise in global crude oil prices. These stocks still have steam left, given the sustained uptrend in oil prices on account of geopolitical concerns.
Axis Bank’s Q3 performance has been buoyed by higher growth in the home loan segment and lower provisioning. The favourable real estate cycle also worked in the favour of NBFCs like Home First Finance, Aditya Birla Capital, and CreditAccess Grameen.
Interestingly, while most mid-tier IT companies are out of investors’ reach owing to their sky-high valuations, Intellect Design Arena is currently trading in the PE Buy Zone.
Leading specialty chemicals player Aarti Industries and healthcare services company Narayana Hrudayalaya were other notable stocks in this list. Aarti Industries plans to demerge its pharma business as "Aarti Pharmalabs" in the next 6 months or so. Coal India, also in the Buy Zone, has gained out of the intermittent energy crises in India occurring in October and November 2021.
Broking companies ICICI Securities and IIFL Securities also find their place in this screener. However capital markets are likely to stay volatile for some time with instability in Europe and rising inflation, so the breakneck growth of the past few quarters for brokerages may not be as visible in Q4.
You can find some popular screeners here.
