Dr Lal Pathlabs and Metropolis to see further margin erosion, says Credit Suisse

Although the diagnostic industry is expected to delivery a 10 percent Compounded Annual Growth Rate (CAGR), the brokerage is concerned over the companies' margin profile as they spend more on customer acquisition, network expansion, digitalisation, and rationalisation of prices of non-specialized tests. "There is additional risk of higher payout structure to franchises, which poses further downside risk to margins," the brokerage said in its note.

Incumbents are also looking to expand in each others' core market. Dr. Lal, for example acquired Suburban Diagnostics in West India and is also expanding in the South, both of which are key markets for Metropolis. Dr Lal had acquired Suburban Diagnostics in an all-cash deal worth Rs 925 crore in October last year.

For Dr. Lal in particular, Credit Suisse expects the company's Return on Capital Employed to fall to 20-25 percent over the next five years, from the current levels of 40-50 percent. It is also concerned about the company's expansion into South India as it sees growth being gradual due to entrenched competition and low brand awareness.

Credit Suisse's price target of Rs 1,400 on Dr. Lal implies a potential downside of 45 percent from Monday's closing price. The stock has already corrected over 40 percent from its 52-week high. "The stock does not seem to factor in impact from competition as its current market price implies revenue growth of 14 percent and EBITDA margin of 24 percent for the next 20 years," the note said.

A slow ramp-up of digital health platforms and a quick turnaround of the Suburban acquisition are some of the key risks to Credit Suisse's estimates.

Credit Suisse has also initiated coverage on Metropolis Healthcare with an underperform rating and a price target of Rs 1,165, implying a potential downside of 22 percent from Monday's closing price. The stock has already corrected 60 percent from its 52-week high of Rs 3,579.

Shares of Metropolis Healthcare are trading 0.7 percent lower as of 12:30 PM while those of Dr. Lal Pathlabs are down 1.5 percent.