A diagnosis of India’s diagnostic companies
Friday, July 8, 2022 by Finshots
In this week's Finshots Markets we discuss the fate and fortune of diagnostic companies
When Covid made landfall, there was pandemonium in the streets. Everybody wanted to know if they’d been infected with this wretched disease. People were getting tested at the first sign of a cough. And they were looking for solutions that would alleviate this angst. That’s when diagnostic companies stepped up to the plate. They offered people the provision to book tests from the comfort of their homes and they made a killing in the process. Naturally, stocks of diagnostic companies like Dr Lal Pathlabs, Thyrocare, and Metropolis Healthcare went on a rip-roaring rally. Investors believed that diagnostic companies were the future. They believed that these stocks held potential,
But the party came to a halt pretty quickly. And despite multiple waves of Covid creating pockets of anxiety across the country, diagnostic companies haven’t yet got their mojo back. If anything, stock prices have crashed as much as 50% in the past year.
So what changed, you ask?
Well, let’s start with the basic premise here — see why these stocks went up in the first place.
Narrative. The pandemic decimated most stocks. But investors were still looking out for decent opportunities within the equity universe. And when it became evident that Covid was here to stay, they saw an opportunity in the healthcare industry.
But even within the healthcare sectors, they were obvious winners and losers For hospitals, it wasn’t ‘business as usual.’ People began postponing non-life-threatening surgeries and consultations. Foreign citizens began deferring their travels (these people would nearly 10–15% to a hospital’s topline). And in general, hospitals were under a lot of pressure, to be fair with their pricing. Meanwhile, diagnostic companies had a free hand. These stocks weren’t exactly an investor’s darling before Covid. But when home-testing took off in a big way, people began weaving narratives about a paradigm shift. It worked.
However, as vaccines emerged and people began going about their life, as usual, some of the exuberance took a hit. People even began switching to home testing kits. They could simply shell out a couple of hundred bucks and test themselves at home. Revenues took a small hit.
But that should be just a minor blip, no?
It very well could be. After all, there’s increasing awareness about how easy it is to just sit at home, get pricked, and then have your results delivered to your phone in the palm of your hand. Also, all those new patients who signed up during Covid could become repeat customers. So it’s hard to imagine that the future trajectory will change drastically for these companies.
But there’s also a big headwind now. You see, the entry barrier to the diagnostic industry is quite low. You don’t need a lot of money to set up a threadbare diagnostic centre and regulations are pretty scant. For decades, this is how the industry grew. It was an unorganized sector with multiple small players relegated to their localities.
But then the likes of Dr Lal Pathlabs and Thyrocare saw an opportunity to change things. They set up labs nationwide, digitized operations and utilised a Hub and Spoke model with centralised testing. They also invested heavily in marketing their services. Private equity investors also lined up to get a bite of this highly underpenetrated market.
But this success has encouraged other players. Just look at the big conglomerates. They’re betting that the awareness driven by the incumbents will bode well for them as they set up their diagnostic chains. Tata acquired e-pharmacy 1MG and launched its own diagnostics wing. Reliance also launched its own diagnostics wing a while back and then acquired e-pharmacy Netmeds to boost growth. Even large hospital chains like Apollo, Max, and Aster are getting into the act and investing aggressively to set up distinct collection centres and grab a share of the pie. And with deep pockets, they’ve all been hell-bent on offering deep discounts and grabbing volumes. It’s an all-out pricing war.
Now if you’re an investor in these companies, you have to ask yourself a couple of questions — will margins deteriorate due to this competition? And will the large diagnostic players soon disrupt the market?
If the answer is yes, it’s understandable why diagnostic stocks have taken a tumble.
But if you’re the optimistic kind, you could make a different arguement.
Take Metropolis for instance. According to a report from JM Financial, 80% of Metropolis’ revenues come from acute patients. Why’s that important, you ask? Well, think of acute patients as those who have a bout of illness or injury that needs immediate, active, and short-term intervention. Invariably, they end up visiting a doctor who may recommend further diagnostic tests. Now that kind of a business isn’t all that likely to be affected by pricing, is it? After all, most people tend to rely on their doctor’s suggestions. So it does seem like the business is largely insulated from the threat of sudden disruption.
At the other end of the spectrum, you have a diagnostic company like Krsnaa Diagnostics who primarily dabble with radiology. Meaning things like MRIs and CT scans. Now, these services aren’t readily available in the unorganised diagnostics space since it costs a pretty penny to set up the whole thing and over 30% of its revenues in FY22 came from this segment alone. This could probably give it some breathing room since other entrants are primarily concentrating on standard pathology services (blood tests).
There’s also the fact that awareness about health and lifestyle-related diseases is on the rise every day. And so you could make an argument that the narrative for certain diagnostic companies hasn’t changed entirely.
Yeah, that’s kind of where we stand. But we would love to know where you fall on this spectrum. Do you think diagnostic companies still hold potential or do you think the rally was simply a flash in the pan? Let us know your thoughts.
Ditto Insights: When you’re worth more dead than alive
If you ever try buying a term insurance policy, you’re likely going to get asked a few details. These details may include your name, your age, your past medical history and your salary details. You can understand why they’d need your name. They have to identify you. They need to know your age because you’re likely to be a more risky proposition as you grow older. They need to know your past medical history because it helps them decide whether they want to insure you or not. After all, if you’re already dealing with a debilitating disease, then the insurer will not extend a policy because they know they’ll likely have to pay out a massive sum soon enough.
But why salary? Why do insurers go to extreme lengths to make sure you have a stable income?
Well, one obvious reason is that they want to make sure you’ll be able to come good on the premiums every year. They don’t want somebody who makes a purchase beyond their means only to let the policy lapse after a year. That would be slightly detrimental to their cause because they spend a lot of money to acquire you (as a customer) and they want you to keep paying your premiums at least for a few years (so they make some money off of you). But there’s a more fundamental reason. They do this to avoid the problem of moral hazard.
See, a term insurance policy is expected to replace your income in your absence, so that your dependents will have something to live off of. But if they ignore the salary metric altogether and extend a massive cover, then you may start thinking you’re “worth more dead than alive.” You may feel overinsured. You may take risks that otherwise seem excessive. Your behaviour may change simply by virtue of having such a massive safety net. This is undesirable for the insurance company. They don’t want you are taking excessive and they most certainly don’t want you dying.
In fact, some states in India have seen an increase in suicide rates, simply because the government compensates the bereaved family after the loss of the primary breadwinner. And term insurance policies offer economic incentives to commit suicide when the policyholder believes the nominees may substantially benefit from their decision.
So to make sure you’re always worth more alive than dead, the insurance company rigorously combs through your salary statements and extends a cover that is in line with your income. And yes, we still think you should buy a term insurance policy if you have dependents who rely on your income. And you can talk to us at Ditto if you're interested in knowing more.