research investment idea 31 mar 2017 dr. lal...
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PCG RESEARCH INVESTMENT IDEA 31 MAR 2017
Dr. Lal PathLabs
Private Client Group - PCG RESEARCH P a g e | 1
Industry CMP Recommendation Add on Dips to band Sequential Targets Time Horizon
Healthcare Rs. 960 BUY Rs. 890 - 960 Rs. 1090 - 1235 3-4 Quarters
HDFC Scrip Code DRLALPEQNR
BSE Code 539524
NSE Code LALPATHLAB
Bloomberg DLPL
CMP – 31 Mar 17 Rs 960
Equity Capital (Rs cr) 82.7
Face Value (Rs) 10
Equity O/S (cr) 8.27
Market Cap (Rs cr) 8080
Book Value (Rs) 82
Avg. 52 Week Volumes
118344
52 Week High 1280
52 Week Low 792
Shareholding Pattern (%)
Promoters 58.6
Institutions 36.0
Non Institutions 5.4
PCG Risk Rating* Yellow * Refer Rating explanation
Kushal Rughani [email protected]
Company Background
Dr. Lal Pathlabs (DLP) is a leading player in the fragmented & competitive Indian diagnostics market.
Established in 1949, DLP based company has been able to widen its reach to a pan-India network on the back
of strong brand equity and a scalable hub & spoke model, whereby specimens are collected from multiple
locations within a catchment area or region for shipment to a clinical laboratory for centralized diagnostic
testing. This network boasts of a National Reference Laboratory in Delhi (2010), over 172 clinical laboratories,
1,559 patient service centers and 4,967 pick-up points. The company has 172 labs, most of which are in
Northern Region and It is the highest revenue contributor with 72% contribution.
DLP possesses capabilities to carry out a comprehensive range of ~ 1,110 test panels, organized into ~ 1,934
pathological tests and ~ 1,561 radiology & cardiology tests & services in its quality laboratories which have
been accredited by the College of American Pathologists (CAP) and National Accreditation Board for Testing &
Calibration Laboratories (NABL). Its customer mix of individual patients, hospital tie-ups and other healthcare
providers & corporates enabled DLP to test over ~ 22.2 mn & ~ 26.3 mn samples and ~ 10.1 mn & ~ 12.0
mn patients in 9M FY17 & FY16 respectively. Its centralized information technology platform is the backbone
of its efficient operations as it integrates its network through a common logistics & payments system, thereby
allowing efficient collection of samples & payments and offers convenience to healthcare providers & patients
in locating patient service centers, booking tests and accessing test results online through their website &
mobile app. DLP has established an international presence as well through its partners in the Middle East,
Africa & South East Asia.
Investment Rationale
Diagnostic market size to touch ~US$ 9.8bn by FY18E
Strong brand Dr. Lal PathLabs supported by self-sustaining business model
Has a network of 172 labs, 1500+ PSCs and 4500+ Pick Up Points
Well defined Strategy in place – “Hub and Spoke Model”
Patient Service Centres (PSC) – quickest way forward for expansion
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 2
Risk & Concerns: aa View & Valuation: Talwalkars Better Value
To set up two more reference Labs at Kolkata and Lucknow
Set to post 20% revenue and 33% PAT cagr over FY16-19E
Strong Free Cash Flows and robust balance sheet
Diagnostic market size to touch ~US$ 9.8bn by FY18E
The size of the diagnostic services market in India is estimated at US$ 6.5bn inFY15 and the industry is likely
to post 17% cagr to touch US$ 9.8bn by FY18E. Moreover almost 82-85% of market remains unorganized
which leaves significant opportunity for the organized players like SRL diagnostics, Dr. Lal PathLabs,
Metropolis etc. DLP has posted 20% revenue and 33% PAT cagr over FY12‐16 with operating margin range of
~23‐27% and robust RoE/RoCE of 30‐35%. We expect ~19% revenue cagr and 21% PAT cagr over FY15‐18E
with 230bps margin expansion. Management is keen on to expand its presence in existing markets such as
North and East. DLP is setting up two more Reference labs in Kolkata and Lucknow. In other geographies,
Company is likely to do network expansion through strategic acquisitions and partnerships. As part of growth
strategy, company also plans to foray into international markets by opening laboratories in neighboring
countries such as Nepal, Bangladesh and Sri Lanka, as well as selective entry into African and Middle East
countries. Currently, International revenues are negligible or to the tune of ~Rs 10cr.
Beneficiary of industry shift
Increasing incomes, medical awareness, emergence of preventive healthcare and only a modest pricing
differential has led to a gradual shift towards regional/national chains that offer a wide range of tests at
attractive rates. Thus, while the industry will grow in the low-teens, we expect the chains to grow in mid-to-
high teens. Company has dominant market share in North market. We believe Dr. Lal’s strong consumer-
brand in its legacy northern market has helped it garner not only market share, but also a premium with
compared to other players.
Unlike pharma companies, which face several headwinds such as regulatory interference and pipeline
pressures, the organised diagnostic industry has limited competition, which should ensure sustainable
volume-driven growth. We expect the Return Ratios to be in the range of 25–30%. We believe these factors
should help Dr. Lal Path sustain its premium valuations. The company has Rs 370cr as cash and current
investments in the balance sheet as on Dec 2016. These are adequate to fund future growth as company is
setting up two additional Reference Labs (Rs 100-110cr) and satellite labs (each lab cost: Rs 3–4cr).
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 3
Strong brand supported by self-sustaining business model
DLP has established itself as a strong brand in the pathology diagnostics market, especially in North India,
which contributes ~70% of the company’s revenues. The hub-and-spoke model has provided the company a
strong competitive advantage versus standalone chains and has helped the company in establishing a strong
foothold in North India around its National Reference Lab. We like DLP’s strategy (1) expansion in a fast-
growing market through well-established hub-and-spoke model, (2) strong franchise network, (3) tapping
new market opportunities such as South and East, all of which are underpinned by a wide array of test menu
and backed by a strong management team and logistics system.
Massive untapped market
The Indian diagnostic market, which is growing at 15–16% per annum, is the result of increasing healthcare
penetration in India as well as a surge in non-communicable disease. This combined with increasing spend on
healthcare has led to a double-digit growth across the healthcare space—pharma, diagnostics and healthcare
services such as hospitals. The national chains such as Dr. Lal Path, SRL and Metropolis form miniscule 6–8%
of the Rs 380bn diagnostic market.
Well-defined strategy in place; Hub-and-spoke model
Dr. Lal has a well-defined strategy, which can fuel sustainable growth, going forward. The hub-and-spoke
model ensures that high-capex incurring reference labs are fewer in number and expansion is mainly through
clinical labs, patient service centres (PSC) and pick up points (PUPs).
This includes the National Reference Laboratory in New Delhi, 172 other clinical laboratories (of which 166
are owned), 1,559 PSCs and almost 5,000 PUPs. The specimens are collected across multiple locations within
a region for delivery to a clinical laboratory for centralised diagnostic testing; this not only provides for
greater economies of scale, but also offers a scalable platform for the continued growth of the business.
A regional reference lab is located in or around a metropolitan city. It accumulates samples from satellite
labs and PSCs across the region. Usually these are equipped to do a variety of tests ranging from the most
basic to the specialised ones including radiology. The newly opened labs generally get break-even within 4-5
quarters from commencement of operation. They perform basic testing functions through the samples it
generates as well as those acquired from PSCs. The more complex tests are referred to the regional
reference/national reference labs.
Collection centres are an effective way to enhance the sample collection. They are located in nursing homes,
hospitals, pathology labs, doctors’ clinics and also on rented premises. They are either company-owned or
franchised, in which case company pays as franchisee fee to get the license to operate a collection centre for
a satellite lab.
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 4
DLP is setting up another two reference Labs at Kolkata and Lucknow
Dr. Lal PathLabs has been granted land in New Town, Kolkata, covering an area of approximately 1,500
square meters, by the West Bengal Housing Infrastructure Development Corporation Limited, for construction
of regional reference laboratory in Kolkata. The majority of clinical laboratories and other business premises,
including patient service centers and local corporate offices, are leased. Typically, the leases range from five
to seven years.
With an aim to ramp up its capabilities in routine & specialized tests in its core markets similar to its Delhi
clinical facilities, the company has decided to construct a 50,000 square feet regional reference lab in
Kolkata. This lab is expected to be commissioned by Sep 2017 at a capex of ~Rs 50cr. One more such lab is
expected to come up by H2 FY19 in Lucknow. Thus, these two labs would enhance DLPs revenues
substantially in the coming years. This would have twin benefits of raising DLPs brand equity in a big way
and de risking its business with reduced dependency on its New Delhi facilities for specialized testing.
PSC – quickest way forward for expansion
Dr. Lal has swiftly expanded its Patient Service Centre (PSC) network from 824 in FY13 to 1,559 in FY16, of
which 1,475 are exclusive franchisees. Management has indicated that the trend to expand through PSCs is
likely to continue in the coming years as well. This enables the company to: a) expand geographically with
minimum capital pressure and also increase brand awareness; b) raise volumes that will boost asset
utilisation, and c) increase volumes, which will lead to better bargaining power with suppliers and thus lower
input cost. DLP provides technical, personnel and marketing support to these franchisees and also requisite
consumables and collection materials. The agreement ranges from a period of five to nine years and it
operates under a revenue sharing model.
Premium valuations justified given strong growth; Recommend BUY with TP of Rs 1235
We initiate on Dr. Lal PathLabs with a BUY recommendation with a target price of Rs 1,235. The company is
one of the key players in the organised space of a highly fragmented market. We see DLP to be key
beneficiary on the shift toward the organised space. While other players Thyrocare, Metropolis and SRL—will
provide stiff competition, an expanding geographic footprint should ensure that growth rates remain
unaffected as Dr. Lal’s brand building starts to deliver in the form of higher business from standalone
centres. Furthermore, the hub-and-spoke business model ensures a low capital outlay and quick initiation of
labs.
Dr. Lal PathLabs has posted 21% revenue and 30% PAT cagr over FY13‐16 and we expect the momentum to
continue over the next 2‐3 years. We forecast 21% revenue cagr over FY16-19E led by growth from across
the board all the geographies. We expect smaller geographies like West and South to exhibit faster growth
given the smaller base. As per management commentary, we believe that company would maintain margins
25-26% in the next 2-3 years.
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 5
Margins would remain compressed given company is opening newer labs, rationalising its PUPs and to open
another two reference labs. We foresee company to post 21% PAT cagr over the same period. Company has
172 labs as Mar2016.We expect company to add 35-40 labs over FY16‐19E with nominal rise in revenue per
laboratory. We build in 19% revenue and 21% PAT cagr over FY15‐18E with ~230bps margin expansion. We
like the underlying business on the back of robust growth in revenues/PAT over past 4‐5 years along with
sustained revenue visibility. Dr. Lal PathLabs has corrected ~28% from its peak of Rs 1280 and now it is
trading at attractive 33x FY19E earnings and 20x EV/EBITDA. We believe that DLP’s long term growth
potential remain intact given superior Brand equity and execution track record. A strong brand franchisee,
stellar return ratios in the range of 30-35%, robust balance sheet and free cash flows justify premium
valuations. The company’s secular growth story and superior return metrics make a compelling long-term
story. We recommend investors to BUY Dr. Lal PathLabs in the range between Rs 890 to 960 with sequential
targets of Rs 1090 and Rs 1235 over the next 4 quarters.
Risks and Concerns
The performance, growth & integrity of the Dr. Lal Pathlabs brand name relies on the performance of
franchisees which control more than 90% of the 1,559 centers as on FY16. Any major allegations
related to Tests / Quality can be severely damaging to the brand equity of DLP which functions in a
competitive B2C market where quality & trust play a major role.
Competitive pressures from both unorganized players which form ~ 85% of market as well as rise of
more regional & pan-India chains can lead to undercutting of prices, suppressing margins.
While the diagnostic healthcare services industry in India is presently not subject to extensive
governmental control, the government could introduce more stringent regulations. Any changes in
regulations or introduction of price controls for the larger benefit of society could have a material
adverse effect on DLPs business, operating revenues & cash flows.
Any interruptions in DLPs Delhi national reference laboratory or its information technology systems
which form the backbone of its entire business model could lead to serious disruptions in operations &
profitability.
Technology adaptation has been one of the strengths and Company has successfully rolled out new
tests on contemporary technology platforms in the past. With continuous availability of new
technologies, DLP needs to remain competitive by ensuring swift adoption of such new technologies
with focus on benefits and returns.
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 6
Financial Summary
(Rs Cr) FY14 FY15 FY16 FY17E FY18E FY19E
Sales 558 660 791 927 1144 1393
EBITDA 138 157 209 246 294 361
Net Profit 80 95 133 163 197 239
EPS (Rs) 9.6 11.6 16.1 19.8 23.8 28.9
P/E 97.1 80.4 58.1 47.3 39.3 32.3
EV/EBITDA 54.4 47.8 35.9 30.5 25.5 20.8
RoE 40.1 32.8 31.2 27.6 26.3 26.3 Source: Company, HDFC sec Research
Comparison with Other Diagnostic Players
Diagnostic Chain Presence Accrediations Laboratories Market Cap (Rs cr)
Dr. Lal PathLabs India, Middle East, Nepal, Malaysia NABL, ISO,CAP,CDC (USA) 172 7985
SRL Diagnostics India, Middle East, Nepal, Africa and Maldives NABL, ISO,ICAL, CLIA,APLAC 265 NA
Thyrocare* India, Nepal, Bangladesh and Gulf countries ISO,CAP, NAGL 1 3850
Metropolis India, UAE, Sri Lanka, South Africa NABL, ISO,CAP, CLIA (USA) 150 NA
Source: Company, HDFC sec Research, NA – not listed on Exchanges, * Operates through centralized Lab at Navi Mumbai
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 7
Revenues to post 21% cagr over FY16-19E
558660
791
927
1144
1393
0
300
600
900
1200
1500
FY14 FY15 FY16 FY17E FY18E FY19E
Rs
Cr
Source: Company, HDFC sec Research
EBITDA and PAT trend over FY14-19E
138157
209
246
294
361
8095
133163
197
239
0
50
100
150
200
250
300
350
400
FY14 FY15 FY16 FY17E FY18E FY19E
EBITDA PAT
Source: Company, HDFC sec Research
Robust Return Ratios (%)
40.1
32.8 31.227.6 26.3 26.3
52.5
42.8 41.2
35.9 34.0 34.6
0.0
10.0
20.0
30.0
40.0
50.0
60.0
FY14 FY15 FY16 FY17E FY18E FY19E
RoE RoCE
Source: Company, HDFC sec Research
Laboratory Count
131
146
164172
0
20
40
60
80
100
120
140
160
180
200
FY13 FY14 FY15 FY16
#
Source: Company, HDFC sec Research
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 8
PSC addition trend over FY13-16
824
1064
1340
1559
0
200
400
600
800
1000
1200
1400
1600
1800
FY13 FY14 FY15 FY16
#
Source: Company, HDFC sec Research
FY19E Revenue Split (%)
70
8
9
13
North South West East
Source: Company, HDFC sec Research
Northern Region revenue trend
409476
570657
804
959
0
200
400
600
800
1000
1200
FY14 FY15 FY16 FY17E FY18E FY19E
Rs
Cr
Source: Company, HDFC sec Research
Revenues trend for Western Region
4757 55
71
92
127
0
20
40
60
80
100
120
140
FY14 FY15 FY16 FY17E FY18E FY19E
Rs
Cr
Source: Company, HDFC sec Research
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 9
Three Different Models
Hospital Based Centres
Diagnostic Centres located within Hospitals. Mostly owned by Hospitals and also given third parties to manage the same.
Diagnostic Chains
Privately Owned Diagnostic Centres with two or more centres. Operates through Hub and Spoke Model of Collection Centres
Standalone Centres
Single Diagnostic Centre. Majority has small scale of operation and offer basic diagnostic tests
Source: Company, HDFC sec Research
Segment wise Diagnostic centres breakup (%)
48
37
15
Standalone Hospital Based Diagnostic Chains
Source: Company, HDFC sec Research
Projected Growth of Indian Diagnostic Industry
37.7
60.5
10
20
30
40
50
60
70
FY14-15 FY17-18P
Rs . '000cr
Source: Company, HDFC sec Research
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 10
Income Statement
(Rs Cr) FY15 FY16 FY17E FY18E FY19E
Net Revenue 660 791 927 1144 1393
Growth (%) 18.3 19.8 17.2 23.3 21.8
Operating Expenses 503 582 681 849 1032
EBITDA 157 209 246 294 361
Growth (%) 13.8 33.1 17.8 19.6 22.6
EBITDA Margin (%) 23.8 26.4 26.5 25.7 25.9
Depreciation 28 28 28 35 40
EBIT 129 181 218 259 321
Other Income 11 20 25 29 32
Interest 0 1 1 1 1
PBT 140 201 240 289 352
Tax 45 68 77 93 113
RPAT 95 133 163 197 239
Growth (%) 18.8 40.6 22.8 20.3 21.8
EPS 11.6 16.1 19.8 23.8 28.9
Source: Company, HDFC sec Research
Balance Sheet
(Rs Cr) FY15 FY16 FY17E FY18E FY19E
SOURCE OF FUNDS
Share Capital 81.3 82.7 82.7 82.7 82.7
Reserves 260 424 589 734 913
Shareholders' Funds 343 510 674 819 997
Long term Debt 0 0 0 0 0
Net Deferred Taxes -25 -12 -18 -18 -18
Long Term Provisions & Others 0 0 0 0 0
Total Source of Funds 332 513 681 823 1018
APPLICATION OF FUNDS
Net Block 92 112 165 195 218
Intangibles 18 16 19 19 19
Goodwill 42 42 54 54 54
Long Term Loans & Advances 17 20 25 32 40
Total Non Current Assets 169 190 263 300 331
Inventories 14 15 20 31 34
Trade Receivables 31 36 48 56 69
Cash & Equivalents 148 230 270 352 451
Other Current Assets (incl Curr Invests) 89 143 184 235 325
Total Current Assets 282 424 522 674 879
Trade Payables 41 52 67 88 112
Other Current Liab & Provisions 78 49 44 55 59
Total Current Liabilities 119 101 111 144 171
Net Current Assets 163 323 411 531 709
Total Application of Funds 332 513 681 823 1018 Source: Company, HDFC sec Research
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 11
Cash Flow Statement (mn)
(Rs Cr) FY15 FY16 FY17E FY18E FY19E
Reported PBT 140 201 240 289 352
Non-operating & EO items -11 -20 -25 -29 -32
Interest Expenses 0 1 1 1 1
Depreciation 28 28 28 35 40
Working Capital Change -57 -65 -54 -30 -75
Tax Paid -45 -68 -77 -93 -113
OPERATING CASH FLOW ( a )
55 77 113 175 173
Capex -67 -35 -65 -60 -35
Free Cash Flow -12 42 48 115 138
Investments 0 0 0 0 0
Non-operating income 11 20 25 29 32
INVESTING CASH FLOW ( b ) -56 -15 -40 -31 -3
Debt Issuance / (Repaid) 0 0 0 0 0
Interest Expenses 0 -1 -1 -1 -1
FCFE -13 41 48 114 137
Share Capital Issuance 1 1 0 0 0
Dividend -12 -23 -33 -52 -66
FINANCING CASH FLOW ( c ) -11 -22 -33 -53 -67
NET CASH FLOW (a+b+c) -13 39 40 90 103 Source: Company, HDFC sec Research
Key Ratios
Key Ratios (%) FY15 FY16 FY17E FY18E FY19E
EBITDA Margin 23.8 26.4 26.5 25.7 25.9
EBIT Margin 19.5 22.9 23.5 22.7 23.1
APAT Margin 14.3 16.8 17.6 17.2 17.2
RoE 32.8 31.2 27.6 26.3 26.4
RoCE 42.8 41.2 35.9 34.0 34.6
Solvency Ratio
Net Debt/EBITDA (x) -1.2 -1.4 -1.5 -1.7 -1.9
Net D/E -0.5 -0.6 -0.5 -0.6 -0.7
Interest Coverage 392.5 418.0 492.3 294.4 360.8
PER SHARE DATA
EPS 11.6 16.1 19.8 23.8 28.9
CEPS 15.1 19.5 23.2 28.0 33.7
BV 41.5 61.6 81.5 99.0 120.6
Dividend 1.3 2.5 3.5 5.5 7.0
VALUATION
P/E 82.5 59.7 48.6 40.4 33.2
P/BV 23.1 15.6 11.8 9.7 8.0
EV/EBITDA 49.1 36.9 31.3 26.2 21.4
EV / Revenues 11.7 9.7 8.3 6.7 5.5
Dividend Yield (%) 0.1 0.3 0.4 0.6 0.7
Div Payout 11.2 15.2 17.7 23.1 24.2 Source: Company, HDFC sec Research
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 12
Rating Chart
R E T U R N
HIGH
MEDIUM
LOW
LOW MEDIUM HIGH
RISK
Ratings Explanation:
RATING Risk - Return BEAR CASE BASE CASE BULL CASE
BLUE LOW RISK - LOW RETURN STOCKS
IF RISKS MANIFEST PRICE CAN FALL 20% OR MORE
IF RISKS MANIFEST PRICE CAN FALL 15%
& IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 15%
IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 20% OR
MORE
YELLOW MEDIUM RISK - HIGH RETURN STOCKS
IF RISKS MANIFEST PRICE CAN FALL 35% OR MORE
IF RISKS MANIFEST PRICE CAN FALL 20%
& IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 30%
IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 35% OR
MORE
RED HIGH RISK - HIGH RETURN STOCKS
IF RISKS MANIFEST PRICE CAN FALL 50% OR MORE
IF RISKS MANIFEST PRICE CAN FALL 30%
& IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 30%
IF INVESTMENT RATIONALE
FRUCTFIES PRICE CAN RISE BY 50%
OR MORE
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 13
Price Movement
100
300
500
700
900
1100
1300
1500
Rating Definition:
Buy: Stock is expected to gain by 10% or more in the next 1 Year. Sell: Stock is expected to decline by 10% or more in the next 1 Year.
PCG RESEARCH
Private Client Group - PCG RESEARCH P a g e | 14
I, Kushal Rughani, MBA, author and the name subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. Further Research Analyst or his relative or HDFC Securities Ltd. or its associate does not have any material conflict of interest. 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