The high-flying diagnostics space will see another IPO, this time from Suraksha Diagnostic a West Bengal focussed player. The diagnostics sector has traded at high valuations driven by shift from standalone testing centres to regional/national chains and rising investments in evidence-based healthcare. Suraksha, an integrated diagnostics operator with Radiology and pathology portfolio has shown high growth and high margins in the last three years.

The high growth though, has been factored into IPO valuations at 27 times annualised Q1FY25 EV/EBITDA or 32 times FY24 EV/EBITDA. This is in line with peers. Investors eyeing the space can wait and watch for now, and look for better entry point after the IPO and with an eye on the expansion plans of the company. The IPO plans to raise ₹846 crore which is entirely an offer for sale from promoters (one-third of the offer) and other investors (66 per cent).

Sector tailwinds

A shift from standalone labs to regional or a national organised sector is the primary driver for the industry. Currently, standalone operators occupy 37 per cent of the market and large chains account for 22 per cent and hospitals account for 38 per cent. Low entry barriers do aid standalone labs which over the years have also built strong relations with local doctors. But the large chains offer brand image, faster turnaround times, test reliability, and a vast array of tests which works in their favour. The centralised testing, logistics and management also allows for cost efficiency favouring the large chains.

The sector is also gaining from shift to evidence-based healthcare in India, which favours the larger chains. Suraksha offers a vast array of 2,300 tests which includes radiology and pathology tests. The diagnostics sector derives 44 per cent value from radiology and 56 per cent from pathology, as per the RHP. Suraksha reported 46/53 per cent revenue contribution from the two in FY24. While pathology uses simple tissue-based tests which do not require expensive machinery, radiology involves X-ray’s, CT Scans and MRIs which can cost as much as ₹8 crore per machine (MRIs). This differentiates Suraksha from even other chains and makes it one of two integrated diagnostics labs (Vijaya Diagnostics and Suraksha).

Suraksha growth drivers

Any diagnostic company including Suraksha have several drivers in the current environment. The simplest is centre expansion. Suraksha follows the industry standard model. A spoke (centre) with adjoining laboratory that serves several hubs (pick up points), along with one central laboratory. A diagnostic test is carried out at the spokes, or the hub or the central laboratory depending on the complexity of the test.

Suraksha has added centres at 8.2 per cent CAGR in the last three years and has 49 centres as of June-2024. The company plans to invest around ₹70 crore per annum (₹7-10 crore for a centre and ₹1.5–2 crore for hub) which should sustain the momentum. It plans on increased penetration in West Bengal (95 per cent revenue contribution) and adjacent North East and Eastern India markets.

Apart from asset addition, asset efficiency also aids volume growth. The number of patients visiting a centre has declined 8 per cent in FY24 to 23,750 visits per centre as new centres were underutilised. Close to a quarter of the centres are less than 3 years old and are expected to ramp up utilisation.

A patient visiting the centre underwent an average of 5.2 tests in FY24 which is amongst the highest in the sector. While scope for expansion on number of tests per patient is limited, the utilisation of centres and the addition of new centres can aid volume growth.

For instance, assuming an 8 per cent centre addition to 52 centres in FY25 along with a 4 per cent recovery in patients per centre and a 4 per cent improvement in tests per patient along a 3 per cent price growth should lead to 20 per cent revenue growth in FY25. The company has added a polyclinic in FY24 (cardio, hypertension, general and diabetes), which should add to growth as well.

Financials and valuation

Suraksha reported a revenue and PAT growth of -1 per cent and 5 per cent CAGR in FY22-24, as FY22 gained from one-time Covid testing volumes. Adjusting for the same, the revenue growth in the period stands at 21 per cent CAGR in the period.

Suraksha reported strong EBITDA margins in the sector at 33 per cent in FY24 behind the other integrated operator Vijaya Diagnostics at 45 per cent. The high radiology contribution shows in the margins. Suraksha reported a revenue per patient of around Rs. 2,000 which is driven by the higher cost radiology tests which are close to 3 times that of pathology. The operating margins can further expand as utilisation (patients per centre) improve. Suraksha also reported that it has constantly increased prices by 3-4 per cent per year which is another unique factor compared to peers. With high competitive intensity and no differentiation in output, price competition is intense in diagnostics with FY24 price hikes across the industry a first in several years.

At 27 times EV/EBITDA the positives are factored into valuations. Investors can look for better entry points. The company should elaborate on growth plans after the IPO which will give more clarity on the investment case for the stock.

Published on November 29, 2024