Market

Downgrade Dr Lal PathLabs to ‘reduce’ with TP at Rs 2,333

We continue to value DLPL at 45x one-year-forward earnings.

DLPL stock has significantly outperformed its peers and the broader market since the start of the pandemic. Since mid-Feb 2020 (when fear pandemic started), the stock is up 106% against a Nifty return of 18%. More recently with the start of the second wave, the stock is up 38% since mid Mar 2021 against a Nifty return of -4% over the period. As a result, DLPL’s valuation has increased substantially to 79.5x one-year-forward earnings compared to 30- 60x in the pre-pandemic period.

We think the stock performance of DLPL was positively impacted by strong contribution from Covid-19 testing since 2QFY21 at high profitability. We estimate that in 3QFY21F, the Covid-19 tests had ~45-50% Ebitda margin compared to ~27% for the non-Covid tests. A recovery in non-Covid test volumes post the lockdown in 1QFY21.

Lower yields and risk premium has positively impacted valuations of long-duration growth stocks. Incrementally, we remain positive on continued growth in non-Covid tests. In 4QFY21, the preliminary results of peers suggest non-Covid revenue growth of 14-20% y-o-y and 7-11% CAGR over 4QFY19-21F.

The profitability of Covid-19 tests may come down, particularly as volumes decline over time given substantial reductions in test prices (from ~Rs 1,500/test to Rs 700-800/test now) by governments. The rise in bond yields will also have a negative impact on valuations.

We factor in higher contribution from COVID-19 tests into our estimates and raise our FY22F EPS estimate by 6%. We assume COVID-19 test volumes peak in 1QFY22 and fall thereafter. Our FY23F EPS estimate is increased marginally by 2%.

We continue to value DLPL at 45x one-year-forward earnings. At 45x FY23F EPS of INR51.8, we arrive at our target price of INR2,333. Our TP implies downside of 30% from current levels. We downgrade our rating to Reduce. We maintain that the fair value range is 40-50x one-year-forward earnings. Our assessment of the valuation multiple assumes strong growth in volumes in diagnostic tests for DLPL in India given underpenetration and market share gains from unorganized players. However, we are likely to see limited upside in EBITDA margins due to competitive pressures from existing and new entrants including e-commerce players, in our view.

Significant value-accretive acquisitions; Higher-than-expected revenue and margin contribution from COVID-19 tests; better competitive landscape; lower cost of equity.

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