Investor interest in the diagnostics space is growing, and the past few years saw plenty of action in the sector - takeovers and inorganic expansion by larger diagnostic chains buying out regional players. In addition, we witnessed the entry of pharma players like Lupin and Mankind Pharma. There were listings of two diagnostic companies in the last year, and the impending IPO of Pharmeasy’s holding entity API Holdings.

Dr Lal Pathlabs is the leader in the diagnostics industry and is also amongst the first to get listed on the stock exchanges. In Q3FY22, it completed the acquisition of the Mumbai-based Suburban Diagnostics, which bolsters its presence in the western region. However, declining profitability in Q3 is a signal that diagnostic companies need to focus on regular or non-Covid revenues as the pandemic wanes and life gets back to normal.

Quick Takes

• The company completed the acquisition of Suburban Diagnostics in an all-cash deal for an enterprise value of Rs 925 crore 
• Revenues grew 9.8% YoY to Rs 496.9 crore in Q3FY22
• Revenues from non-Covid business stood at Rs 438 crore with ‘Swasthfit’ contributing 15% to total revenues
• Covid and allied contributed 11.8% to revenue in Q3FY22 with 5.8 lacs RT-PCR tests
• Net profits dropped sharply by 39% YoY to Rs 57.3 crore in Q3FY22

Diagnostic services companies were quick to capitalise on the opportunity in adversity since the onset of the pandemic in Q1FY21. Surging healthcare spending and demand for Covid-19 tests led to multifold gains for pathology firms. Dr Lal Pathlabs recorded its highest ever annual net profits in FY21 at Rs 280.1 crore along with highest ever annual net profit margin at 18.8%. Similarly, Metropolis Healthcare and Thyrocare too recorded highest ever annual net profits in FY21 at Rs 197.6 crore and Rs 119.8 crore respectively. These gains have started to fade as outbreaks have eased, testing for air travel is not mandatory anymore, and most of the states have completely opened up. Dr Lal Pathlabs follows this pattern with net profits falling sharply in the last two quarters.

Falling profitability sounds the alarm bell

The Q3FY22 results for all the diagnostic companies display a significant fall in profitability. Dr Lal Pathlabs saw a steep fall of 39% in its YoY net profit growth. 

The story was the same for Metropolis Healthcare as well as Thyrocare saw net profits decline by 29.9% and 33.6% respectively. The major reason for the drop in profitability was the reduced number of Covid related tests. Over the last two years, Covid testing played a crucial role in pandemic management. With the third wave receding, diagnostic companies need to rejig their models in order to improve profitability in other verticals. Dr Lal Pathlabs has not increased its non-Covid test prices over the past four years and a price increase in coming quarters will aid profitability.

Regular testing picks up as Covid related testing declines in Q3FY22

Consolidated revenues in Q3FY1 stood at Rs 509 crore, a YoY increase of 9.2%. Net profits stood at Rs 57.3 crore, a YoY decline of 39%. Revenues declined marginally on a sequential basis, but profits declined drastically to Rs 57.3 crore, nearly half of the Q2FY22 profits of Rs 95 crore.

A closer look at the split between Covid and non-Covid revenues shows that there is a gradual recovery in the non-Covid business. In quarters when the spread of the Covid was high like Q1FY22, besieged by the second wave, Covid related revenues were the highest. In Q3FY22, with the third wave of the Omicron variant receding, the Covid related revenues are down 75% from their peak levels.

Within the Covid related business, there is a split between Covid-19 business which encompasses RT PCR tests and antibody tests. Covid allied revenue includes IL-6 & D-Dimer,  CRP, Ferritin & LDH tests. 

Expanding presence from North India to across the country

Acquisition of city-specific and regional diagnostic chains is a growth strategy adopted by two of the leading players in the diagnostics chain space–Dr Lal Pathlabs and Metropolis Healthcare. Both companies bid for the Mumbai-based Suburban Diagnostics and Dr Lal Pathlabs acquired it. The acquisition gives it access to 44 laboratories, diagnostics centers and around 150 collection centers. 

The management said that the western India region is a strategic priority. It plans to leverage the brand recognition of Suburban Diagnostics, wide network and professional management team to accelerate its growth trajectory. With this acquisition, 44 laboratories of Suburban got added to its existing 230 labs, taking the total to 274. During the Q3FY22 earnings call, the management estimated western India to contribute 28% of total revenues post the acquisition against the existing 10%. They expect the Delhi NCR region, their highest contributing region to contribute 34% in the expanded network.

The company is also scouting for suitable acquisition targets in South India and is keen to expand its presence in the region. While Dr Lal Pathlabs completed the Suburban Diagnostics acquisition, close peer Metropolis Healthcare bought Hitech Diagnostic Centre in South India in October 2021.

Integration of Suburban is critical to improving synergies

While prima facie the Suburban acquisition gives Dr Lal Pathlabs a strategic advantage in western India, there are many loose ends that need to be tied up in order to harness the full potential of the deal. Suburban was awarded the contract for RTPCR testing at Mumbai airport and this was its major income for the past few quarters. These tests were charged at around Rs 4000 per test and were later capped at Rs 1900 by the government. This is expected to taper off with testing norms being relaxed for international travel. Suburban’s costs per test/set of tests is higher than Dr Lal Pathlabs by 10%-20%, which may lead to patients gravitating towards Dr Lal Pathlabs for cost efficiency. Suburban’s margins are also lower than Dr Lal Pathlabs. The management has indicated that it would continue using the Suburban brand for now and look at integrating the brand at a later date, but is willing to evaluate an option of dual branding for Suburban centres.

Dr Lal Pathlabs is on its way to become a truly pan India diagnostic chain. Its focus on the non Covid tests and efficient integration of Suburban hold the key for growth in the next few quarters. Within the diagnostics space, this market leader is one that may pique investor interest.