2022 results miss our expectations
　　China Lesso announced its 2022 results: Revenue fell 4% YoY to Rmb30.8bn, and net profit dropped 17% YoY to Rmb2.52bn. The firm’s 2H22 revenue declined 8% to Rmb15.9bn, and net profit stayed largely flat YoY at Rmb1.22bn, missing our expectations due to higher-than-expected impairments.
　　Sales volume of plastic pipes remained solid: The firm’s sales volume of plastic pipes fell 6.1% YoY to 2.39mnt in 2022, with that of PVC and non-PVC plastic pipes declining 4.2% and 11.4% YoY to 1.78mnt and 0.62mnt. Its 2H22 sales volume dropped 7% YoY to 1.27mnt in 2H22.
　　By region: Overseas revenue from pipe products rose 34% YoY to Rmb1bn in 2022, thanks to the firm's efforts to build production facilities in Southeast Asia. While revenue from other regions (except eastern China) declined.
　　Gross margin recovering amid falling raw material prices: Raw material prices fell in 2022, resulting in a 3.5% decline in the ASP of PVC products. The ASP of non-PVC products grew 6.6%. Gross margin of pipe products climbed 1.6ppt YoY to 27.5%. The ASP of PVC products declined rapidly in 2H22, and gross margin of pipe products rose 2.2ppt HoH to 28.6%.
　　Other businesses remained solid; sales of PV products ramping up: Revenue from building materials and home improvement business fell 1.7% YoY to Rmb2.7bn, and that from overseas shopping malls rose 12% YoY to Rmb960mn. Revenue from environmental protection business totaled Rmb350mn. Revenue from the photovoltaic (PV) segment has reached Rmb589mn since its launch in 2H22.
　　Blended gross margin: The firm’s 2H22 blended gross margin edged up 0.6ppt HoH to 27.1%, and net margin fell 1ppt HoH to 7.7% due to increased expenses (financial expenses and impairments).
　　Accounts receivable increased slightly: Turnover days of accounts receivable increased 10 days YoY to 57 days. As a result, accounts receivable grew Rmb660mn YoY to Rmb4.87bn in 2022, and full-year impairment was about Rmb465mn. Interest-bearing liabilities increased and net gearing ratio rose: Interest-bearing liabilities rose Rmb2.9bn YoY to Rmb20bn in 2022, and borrowing interest rate edged up to 4.2% from 4.0% in 2021, driving net gearing ratio up 12ppt YoY to 58%. Capex: The firm expects its capex to be Rmb3-3.5bn in 2023, most of which will be invested in the PV segment. The firm proposed a final dividend of HK$0.3/sh for 2022.
　　Trends to watch
　　Infrastructure construction improving; real estate market stabilizing; diversified businesses boost growth of pipe products. In 2023, we believe infrastructure and municipal projects will continue to grow rapidly, and that the real estate market will stabilize and rebound. We think these positives are likely to boost sales of the firm's pipe products.
　　Meanwhile, we expect sales volume of some new businesses to grow supported by the transformation of the agriculture and new energy sectors. This, coupled with the firm's overseas production bases and distribution channels, may bolster its pipeline business (the firm expects overseas revenue from pipe products to represent over 7% of total revenue in 2023).
　　Financials and valuation
　　As we lower our sales volume forecast, we cut our 2023 EPS forecast 15% to Rmb1.14. We introduce our 2024 EPS forecast of Rmb1.3. The stock is trading at 5.6x and 4.7x 2023e and 2024e P/E. We maintain OUTPERFORM but cut our target price 13% to HK$10, implying 7.5x and 6.3x 2022e and 2023e P/E with 34% upside.
　　Risks
　　Disappointing downstream demand and/or business expansion.