Dr Lal Path Labs: Good Biz. But Something's Not Right

Extending upon an earlier theme of looking at valuations of well known companies with a rather consumer-interfacing operational footprint (e.g. D-Mart), the world of diagnostics offers an interesting case study.  

 

Dr Lal Path Labs, a diagnostic and pathology services company, has an almost ubiquitous presence in Northern India. With its country-wide distribution network through 200 clinical labs, 2,569 Patient Service Centres, over 6,400 “Pick-Up” points), and a rich retail-oriented proposition (including prompt home collection, quality door-to-door service etc.) there’s a good chance that you (or one of your loved ones) have been their customer…if not investor.

 

And at its recent price of INR1,070-ish per share (39x PE, 26x EV/EBITDA), it is perhaps better to be the former.

 

Wish you the best of health. Of course.

 

Dr Lal Path Labs Actuals
Dr Lal Path Labs Actuals

 

Why so Grim?: First things first. Dr Lal Path Labs is a good business. Its revenue this FY grew by 14%, earnings by 17%. It has demonstrated solid 24% plus EBITDA margins and a healthy Return on Equity (ROE) of 23%. The company is very light on leverage, with a relatively controlled capital spend.

 

But the price is too high. Considering a 39x P/E, there is an inherent growth story which is expected, and naturally one would think the stock would be immune from any top-line slowdown or margin pressure.

 

Unfortunately, it has witnessed both. Revenue growth was 20% in 2016, and now at 14% (trending downwards). Similarly its EBITDA has also eroded from 26.5% in 2016 to 24.4% in 2019.

 

Dr Lal Path Labs Forecasts
Dr Lal Path Labs Forecasts

 

Still: To avoid any accusation of superflous glumness, one can grant the company some benefit of doubt while building its Free Cash Flow (FCF) projections.

 

How?: I assumed an upward sloping revenue growth (tapering from 14% in 2019 to 19% in 2029), improving EBITDA margins (spiking from 24.4% in 2019 to 26.4% in 2029 i.e. in-line with historical high) and stable capex amounting to 6% of revenues (in line with last 4 years). I have assumed a historically high revenue/earnings trend & healthy/improving margins…thereby ignoring recent pressures visible on the actuals. Optimism overload. 

 

Still: Even with such a rosy picture, one is compelled to discount this stock at 11.8% to square the Discounted Cash Flow (DCF) value with its present market valuation – almost akin to D-Mart, where anything above a 12-13% WACC was making the stock look overvalued.

 

Is 11.8% defendable?!

 

Well…as per Finance 101, India’s risk-free rate (i.e. proxied by Government of India 10-year bonds) is hovering around the 7-ish% mark. Add 8-9% of country risk premium on top (thanks to Damodaran), and one still arrives at 15%. Anything below that just doesn't do.

 

Conclusion: Good Business, but just too rich. I pass.

 

Click here to view the full spread sheet. Sensitivities shown below.

 

 

 

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