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Hold Dr Lal Pathlabs Ltd For Target Rs.3,405

COVID driven upside; base business steady

Dr Lal Pathlabs’ (Dr Lal) Q1FY22 performance was above estimate due to higher revenue from COVID-19 related tests. COVID-19 and allied tests contribution increased to 36.3% of sales (13.2% in Q4FY21). Base business revenues grew 84.1% YoY, two year CAGR of 7.4% to Rs3.8bn vs estimated Rs4.1bn. Overall, revenue grew 128%, EBITDA margin was up 1300bps YoY to 31.2% and adj. PAT was up 362% to Rs1.3bn on a low base.

The base business was also impacted by 2 nd wave of COVID but has started recovering Jun’21 onwards. We remain positive on Dr Lal given volume growth consistency, ability to execute well and strong return ratios. However, considering recent rally in the stock price which has made valuations fair, we downgrade it to HOLD from Add.

* Strong revenue growth led by COVID related tests: Dr Lal witnessed another quarter of strong growth with 128/41% YoY/QoQ growth. Revenue from RT-PCR and anti-body tests contributed 17.3% and other COVID allied tests contributed additional 19.0% of total revenue. Base business has witnessed a two year CAGR of 7.4%. The volumes (patients) witnessed 103% growth and we estimate strong growth in FY22E on a lower base. Average realisation stood at Rs860 (up 13.2% YoY) on account of higher COVID tests revenue. We believe the company would witness double digit volume growth over longer period given leadership position and shift from unorganised to organised players.

* Operating leverage drove margin expansion: Dr Lal reported an EBITDA margin of 31.2% (+290bps QoQ) vs estimated 28.6%. Higher revenue was the key reason for the same as operating leverage benefit kicked in. However, COVID tests revenue would drop from Q2FY22 as cases have dropped significantly and hence, EBITDA margin would normalise. We expect EBITDA margin to improve 190bps over FY21- FY23E with pick-up in patient volumes, sustaining benefits of cost control and operating leverage.

* Outlook: We expect Dr Lal to outperform industry growth and register revenue, EBITDA and PAT growth at CAGRs of 17.8%, 21.8% and 27.1%, respectively, over FY21-FY23E. RoE and RoCE would remain strong at 27.7% and 26.2%, respectively, in FY23E whereas RoIC would move to ~145%. We are positive on the long-term outlook considering the company’s strong brand franchise with sustainable growth, expansion potential, healthy FCFF generation and strong return ratios.

* Valuation: We raise FY21-FY23 EBITDA estimates by 3-9% to factor in higher revenue from COVID tests and growth recovery in base business. Considering recent rally in stock price which has made valuations fair, we downgrade Dr Lal to HOLD from Add with a revised DCF-based target price of Rs3,405/share (earlier: Rs3,000/share) implying 60.2xFY23E EPS and 41.1xFY23E EV/EBITDA. Key downside risks: Higher-than-expected competition and regulatory hurdles. Key upside risk: continued upside from COVID related tests.

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