The diagnostics sector saw decent traction in the last few years, especially after the coronavirus pandemic hit the world.
But the pandemic was not the only factor which made the sector investors' favourite. Due to its asset-light structure and scope for generating high cash flow, the sector has been under the radar of investors.
However, the entry of new players into the sector has been a cause of concern for the already established players in the sector. As Yash Gupta, Equity Research Analyst at the brokerage firm Angel One pointed out diagnostics stocks have corrected more than 50-60 percent in the last six months, due to an increase in the competition in the industry and margin pressure while covid benefits faded away.
The variable of strong competition remains an overhang for the sector. So, what should be the strategy for diagnostics players?
"Once the favourite of investors, due to asset-light structure, high cash flow generating capability, healthy return ratios and visibility of sustainable growth over medium to long term, diagnostic companies are now losing the charm with a sharp jump in competitive intensity led by new entrants backed by large conglomerates," brokerage firm ICICI Securities pointed out.
The brokerage firm believes while the Indian diagnostic sector is expected to grow in the low to mid-teens over the next few years supported by industry tailwinds, there is tremendous pressure on incumbents and new entrants to grow faster than the industry.
Low-entry barriers and historically lucrative returns could entice more players towards the sector resulting in lower-than-estimated growth for organised players in the market. Still, ICICI Securities believes the sector has enough positive attributes to outweigh the negatives.
"We continue to remain overweight on the sector. The near-term growth is likely to be under pressure due to the waning covid-19 opportunity. Additionally, intensified competition has dented the sentiment of the sector, resulting in steep price correction of listed stocks (nearly 50-60 percent from their all-time highs). We believe the current valuations largely account for these concerns. Industry tailwinds, high B2C contribution, speciality tests and geographical expansion provide enough growth opportunities," ICICI Securities said.
The brokerage firm has 'buy' call on Dr Lal Pathlabs (target price: ₹2,981), Metropolis (target price: ₹2,187), Thyrocare (target price: ₹980) and Vijaya Diagnostics (target price: ₹614).
Gupta of Angel One believes diagnostics companies' valuations seem to be reasonable at the moment, down from EV/EBITDA of 50-60 times to 20-25 times.
"We have a buy call on metropolis as we believe that all near term negatives have been priced in the stock and as covid cases increasing in MMR region company will get some benefit of the Covid business," he said.
However, some analysts have a dissenting view on the sector as they believe the sector's highly competitive nature is a major negative.
Akhilesh Jat, Category Manager - Equity Research, CapitalVia Global Research is of the view that the diagnostics market along with the home testing has picked up as people have become more conscious about their well-being and, hence, get themselves tested regularly.
"Competition from the unorganised players in tier-2, tier-3 cities and remote areas is a major hurdle for the diagnostic industry. The near-term market trend of the diagnostic stock is weak and one should avoid investing in these stocks. The diagnostics industry enjoys greater value and importance, however, it is highly unorganized," said Jat.
Disclaimer: The views and recommendations made above are those of individual analysts or broking firms and not of MintGenie.
