Metropolis Healthcare and the Indian Diagnostic Industry

Metropolis Healthcare is play on the evolving diagnostics industry of India. An underpenetrated industry with the dynamics favoring the organized players, Metropolis should be able to take advantage of the favorable tailwinds.

The diagnostic industry acts as an information intermediary between the doctors and the patients i.e., they provide the information necessary for doctors to act upon. It is a part of the much bigger Healthcare industry. The Indian healthcare industry has five key functional sub-sections: healthcare delivery (hospitals) is the largest segment, followed by the pharmaceutical, medical devices, diagnostics and healthcare insurance segments.

The diagnostics industry is ~9% of the Healthcare industry and has been growing at high teen rates for some time due to natural under penetration of diagnostic services as well as better awareness. The double digit growth of the industry is expected to continue in the foreseeable future.

Urban population accounts for ~65% of the diagnostic industry due to better healthcare infrastructure, higher income levels and awareness.

The diagnostic industry can be classified into pathology testing services and imaging diagnostic services. Pathology testing or in-vitro diagnosis involves the collection of samples, in the form of blood, urine and stool and analyzing them using laboratory equipment and technology. Imaging diagnosis or radiology involves imaging procedures such as x-rays and ultrasounds, which help mark anatomical or physiological changes inside a patient’s body. It also includes high level tests such as MRI and CT-Scan.

There is a big difference between the two branches of diagnostic industry based on how these two segments scale. The pathology business is highly scalable as blood samples can be shipped to a remote, centralized location to achieve economies of scale. In contrast, imaging business operators have to install diagnostic equipment close to the patient. Imaging services cannot be centralized and, as a result, are difficult to scale up. Thus the pathology side takes the cake here and accounts for more than 50% of the revenues in diagnostic industry. While the technical classification of the pathology industry is based on methods used and types of diseases targeted for investigation, a simpler method is based on complexity of tests performed.

In the diagnostic industry, the preventive and wellness segment accounts for 7-9% of the total market. This segment is expected to grow the fastest due to increased awareness of preventive and curative healthcare as well as focus of the corporate sector on the well-being of their employees, promoting them to undergo preventive and wellness tests.

There are different types of diagnostic service providers in India such as:

Standalone diagnostic centres: These are your next door diagnostic service providers with a single laboratory or centre.

Hospital-based diagnostic services: This includes include public and private hospitals providing diagnostic services at the hospital for patients who are either admitted as an in-patient or are treated as an out-patient of the hospital.

Diagnostic Chains: Diagnostic chains which constitute the organized market, offer pathology and imaging services and operate out of more than one centre with large chains that have a pan-India presence.

Currently, the organized diagnostic chains account for 16% of the total diagnostic market while standalone centres and Hospital based centres account for 47% and 37% of the market. This is clearly an industry where the thesis is based on market share shift from unorganized to organized sector.

Your next door diagnostic lab will probably not care that much about accreditation from regulatory authorities when such accreditations are not mandatory. Chances are also high that they will fail big time in case of any quality checks and standardization. This puts the organized diagnostic chains in the sweet spot to gain the trust of the customers by proactively seeking accreditations and maintaining quality standards. Currently, <1% labs are NABL certified in India and this number will increase with time giving the organized chains an edge, as they are better equipped to get their labs certified.

The listed diagnostic players such as Dr. Lal Path Labs and Metropolis Healthcare work on a hub-and-spoke model. This model involves incorporation of one main lab where all types of testing facilities are available and a network of collection centres around the lab which provide it with the required samples.

Companies usually establish a satellite lab for a given area which is equipped with necessary equipments to carry out semi-specialised and specialized tests while more advanced tests are taken care at regional or national labs. The satellite labs get the required samples from collection centres distributed across the city in which the company operates in. These collection centres can be company owned or franchised and collect samples from patients either through home collection, doctor referral or patient drop in.

One key feature of the diagnostic industry is the reagent rental model of the diagnostic equipment supply. Under this, the companies which provide the equipments usually give it out free of cost to the diagnostic companies if they agree to offtake a minimum fixed amount of reagent on an annual basis. Since reagent is the main cost for the industry, and meeting the minimum offtake requirement of suppliers is not possible for the smaller standalone diagnostic service providers, there is a lot of scope here to eat out of the pie of the unorganized players and that is why this industry is the one where the more you spread out and increase your scale, the better your economics turns out to be.

Lets dive into Metropolis now.

Metropolis Healthcare

Metropolis Healthcare offers a comprehensive range of clinical laboratory tests and profiles, which are used for prediction, early detection, diagnostic screening, confirmation and/or monitoring of the disease. The profile comprises of a variety of test combinations which are specific to a disease or disorder as well as wellness profiles that are used for health and fitness screening. The tests include:

• ‘routine’ tests such as blood chemistry analyses, blood cell counts and urine examination;
• ‘semi-specialized’ tests such as thyroid function tests, viral and bacterial cultures, histology, cytology and infectious disease tests; and
• ‘specialized’ tests such as tests for coagulation studies, autoimmunity tests, cytogenetics and molecular diagnostics.

Network

Metropolis has presence in 19 states and 210 cities of India with leadership position in west and south India. The company operates outside India also with laboratory operations in Ghana, Kenya, Zambia, Mauritius and Sri Lanka. In addition, it has also entered into agreements with third parties for collection and processing of specimens in Nepal, Nigeria, UAE and Oman. Revenue contribution from west/south/north/east/international stood at 58%/25%/7%/5%/5% as of Q2FY22.

Metropolis’s laboratory network consists of a global reference lab in Mumbai which undertakes all types of specialized, semi-specialised and routine tests. It has 13 regional labs (3 outside India), 54 express labs and 64 satellite labs. It has 3006 collection centres, of which 255 are company owned, 2076 are third party service centres and 675 are Assisted service centres.

Metropolis serves customers through its 10,000+ collection centres. Samples are collected at any of the collection centre and then transferred to a clinical lab that can be satellite/express/regional/global reference lab based on the complexity of the tests to be performed.

The company also serves institutional customers through its tie ups with independent private healthcare set ups including large and small-scale hospitals, nursing homes, private laboratories, radiology centers, diagnostic centers, IVF centers and other healthcare service providers. Specimens are collected from the pick-up points, on a periodic basis, either through the company’s own logistics team or through an independent courier agency and sent to a reference lab.

Granular Focus on Cities

Metropolis has divided the cities it operates in, into focus cities, seeding cities and other key cities.

Focus cities are cities where the company has a significant presence and operational experience. It includes Mumbai, Bengaluru, Chennai, Surat and Pune. The company intends to deepen its penetration in Focus Cities by increasing the number of third party service centres and enhancing its laboratory capacity.

Seeding cities are cities which are expected to have strong growth potential. It comprises Rajkot, Nashik, Nagpur, Kochi, Raipur, National Capital Region, Kolkata and Guwahati. Seeding Cities are expected to be the core focus of the company’s medium to long term growth.

Other key cities are cities where the company has presence through satellite or express laboratories or through partnerships. Revenue Mix between Focus/Seeding/Others Cities stood at 61%/20%/19% as of Q2FY22.

B2B/B2C Mix

B2B segment involves collaboration with hospitals and nursing homes who outsource their specialized and semi-specialised tests to the diagnostic chains due to insufficient volumes to carry out these tests on their own. B2B provides diagnostic chains with customers that they might have difficulty in sourcing when they first enter any city. B2B however stretches the receivable cycle of the companies.

Metropolis also selectively looks at government contracts and currently it has a contract from NACO to collect blood specimens from 525 government-owned antiretroviral therapy (ART) centers and conduct HIV-1-Viral load tests.

Once a company has established slight brand recall in a particular city, it looks to transition towards B2C segment through third party/franchisee route. B2C contribution in focus cities of Metropolis has been increasing due to aggressive network expansion and integrated brand building campaigns to establish Metropolis as a trusted brand in the mind of consumer and the doctor. B2C share has increased from 45% in FY17 to 58% in FY21 and the company has targeted to take the contribution to 65% in the near future.

Regular Acquisition

Diagnostic chains have demonstrated a history of regular acquisition. This is driven by the aim of gaining entry into new markets, strengthening presence in an existing market or acquiring a well-oiled diagnostic network in a city.

Metropolis has a track record of acquiring and successfully integrating companies to grow its portfolio of laboratory and service network. It has acquired several companies since 2002, which includes established local chains such as Sudharma Metropolis Health Services Private Limited in Kerala and Golwilkar Metropolis Health Services (India) Private Limited in Pune as well as companies outside India.

The most recent acquisition of Metropolis is that of Hitech Diagnostics, a laboratory chain in the South India market with a network of 31 laboratories including 3 NABL and ICMR accredited laboratories and 68 collection centres. Hitech is a formidable player in the focus cities of Chennai and Bengaluru and has large B2C footprint. It has a Test menu of 1,100+ tests ranging from routine to highly impenetrable molecular & genetic assays. Hitech has been acquired in all cash deal for Rs. 636 Crores, funded through internal accruals and debt of Rs. 300 Crores. It did sales of 121 crores in FY21 but more than 40% was contributed by covid 19. Based on pre-covid trends it would have done sales of around 90-100 crores sans covid so a nomalised multiple comes out to be around 6x sales. It also operates at ~30% EBITDA margin and ~30% ROCE.

Future Strategy

Metropolis has crafted a clear strategy for the next 2-3 years to grow the business. It plans to add 90 labs and 1,800 service centers over next 3 years to strengthen its leadership position in existing geographies and build Metropolis brand in new geographies. Main cities that management has chosen for the expansion lie in Madhya Pradesh, Maharashtra, Gujarat, Uttar Pradesh, Orissa, Jharkhand, Telangana and Andhra Pradesh. It is also looking to expand home visit coverage to 100 locations in 1 year and cover 200 locations within 2 years to make Metropolis the Go-To brand for home testing.

Metropolis has been focusing on driving up the share of B2C business in the total revenue mix and focus and B2C mix in the “focus cities” is clearly increasing. Going forwards, the same strategy will be applied to any city where the brand establishes a presence. This will support the margins as strong growth plans in the next few years will take some time to reflect in the numbers.

Negatives

Highly Competitive Industry – Indian diagnostic industry is highly competitive with no entry barriers. Organised diagnostic chains like Metropolis compete with standalone diagnostic chains spread across cities as well as diagnostic arm of hospitals. A number of PE/VC backed e-diagnostic players are also operating/entering the field. These players have access to deep pockets of their investors which increases the competitive intensity of the sector manifolds.

Geographical Concentration – West and South India accounts for ~80% of Metropolis’ revenues and at the same time, the focus cities account for >50% of the company’s revenues exposing the company to high dependence on fewer pockets.

Stretched Receivables Cycle – Due to a comparatively higher share of B2B in total revenues as well as the NACO contract, Metropolis has operated at a higher receivable days compared to DLPL.

Financials

Metropolis has grown revenues at a CAGR of 16% over the last 5 years compared to 15% CAGR in Dr Lal Path Labs. EBITDA has increased at a CAGR 20% over the last 5 years between FY16 and FY21 while DLPL has given EBITDA CAGR of 16%. PAT has grown from 82 crores in FY16 to 183 crores in FY21 at a CAGR of 17%, similar to DLPL.

Debt is not a concern for both Metropolis and DLPL, both have operated at less than 0.2x D/E for last few years and that situation shouldn’t change unless they go for a really big acquisition. Due to the asset light nature of the industry, both Metropolis and DLPL has operated at >3x fixed asset turnover. That said, DLPL has delivered better efficiency and has operated at ~5x fixed asset turnover. On the receivables side, Metropolis has considerably higher receivables days due to higher B2B mix and NACO contract. Receivable days touched a high of 65 days in FY19 and has dropped to 45 days in FY21.

Cash conversion for Metropolis has been healthy with last 5 years’ average CFO/PAT at 113% and 22% CAGR in CFO between FY16 to FY21. Metropolis has consistently generated free cash flow and FCF has compounded at 13% over the past 5 years.

ROE and ROCE has been >25% over the last 5 years.

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