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Core Diagnostics buy – Pros and cons

Metropolis recently purchased Core Diagnostics at 2.2x revenue funded by Rs1.4bn cash and Rs1.1bn in shares. Key positives that have been already highlighted include specialists connect in growing therapy and cross sell specialized tests of Metropolis to customers of Core. However, in this update we touch upon few factors that might make the acquisition not such a uniformly positive one. Firstly, deal would be ROE and ROCE accretive only from FY28. Secondly, high-end cancer testing market by definition would have low volumes so investment made would have fewer patients to contend with. Thirdly acquisition does not solve the volume growth issue thatremains a lingering concern. Lastly opinion is divided on whether cancer testing is best done under an independent chain or should be left to oncology focused/multi-specialty hospitals. We incorporate Core financials into our estimates and cut gross margin estimate by 2% and EPS by 4.4% in FY26. Albeit margin impact would recede in FY27 as Core turns profitable likely next fiscal. Our ex-Core Diagnostic estimates remain largely unchanged, and we stick to 35x FY27E EPS with revised TP Rs2,000 (earlier Rs1,600) and Reduce rating.

Impact of Core Diagnostics buy may not be a uniformly positive one

While we are cognizant of the deal positives, in this update we highlight few pointers that might not make it a uniformly so. Being oncology focused, it has low volume and high value tests. OPD nature of testing and lack of insurance cover entails keeping tests affordable; this leads to lower gross margin compared to routine pathology business. Hence the break-even timeline is longer, and Core Diagnostic could be operating at a EBIDTA loss (or possibly a low single digit margin). We reckon bulk of the margin difference between the two businesses is traced to gross margin difference which stands at 55-60% for Core Diagnostics.

About 2% gross margin dilution and slight EPS pullback in FY26

A presumed 55% gross margin for Core leads to ~200bps gross margin dilution in FY26 as we factor in Rs1.2bn revenues added to Metropolis. Higher operating costs would lead to ~150-170bps margin dilution upon consolidation next year flowing into slight EPS pullback due to the merger. Margin would remain impacted due to the B2B nature of business and near-term efforts to rationalize lab presence and process synchronization. We assume ~15% revenue growth in FY27 largely on back of (high end) oncology test market growth and contribution from cross selling of Metropolis specialized tests to hospitals connected to Core network.

‘Expectation of Core turning profitable in FY26’

In its post-acquisition call, management highlighted a) EBIDTA pay back of 6-8 years and 9-10 years on PAT basis b) Do not offer super specialized tests within Metropolis and it would have taken 5+ years hence acquisition accelerates oncology capabilities c) Over the life cycle of a cancer patient, about 3-4x number of tests are required of which about 1/3rd would be oncology linked and rest would be routine especially done after remission which is currently not done in Core but can be taken care of by Metropolis d) Only 30% overlap in oncology tests with Metropolis and rest is exclusive to Core e) Core gets lots of testing from medical oncology and nearly 85% of revenues come from such OPD type of demand Surprise on volume growth key for a constructive stance We retain high single digit growth in patient footfalls in FY25/26 along with 4-5% mix change driving 11-12% ex-Core revenue growth. While there have been modest downgrades in last 12 months, we believe a more constructive stance is dependent on volume surprise beyond 7% reported in H1 FY25. Retain Reduce based on an unchanged 35x FY27E EPS and await evolving volume growth trajectory

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