1H23 results beat our expectations
　　China Lesso announced its 1H23 results: Revenue rose 2.7% YoY to Rmb15.30bn; net profit attributable to shareholders grew 15% YoY to Rmb1.4bn, beating our expectation, mainly due to higher-than-expected GM.
　　Main pipe business contributed earnings; new businesses grew steadily.
　　1） Sales volume of plastic pipes showed resilience: In 1H23, sales volume of plastic pipes rose 14% YoY to 1.27mnt, with that of polyvinyl chloride （PVC） and non-PVC plastic pipes rising 13% and 17% to 0.94mnt and 0.34mnt. Meanwhile, the firm cut product prices due to a sharp decline in raw material prices, and the ASP of its pipe products fell 16% YoY in 1H23 to Rmb9,596/t （ASP of PVC and non-PVC pipes down 21% and down 8% YoY）。 As a result, total revenue from plastic pipes dropped 4.2% YoY to Rmb12.23bn.
　　2） Project transformation and channel improvement: Given the downturn in the real estate sector, the company actively transformed its customer base for its pipe products, acquiring new clients such as state- owned enterprises （SOEs）， local government financing vehicles （LGFVs）， and agriculture companies. By product application, revenue from water supply, drainage, and power supply & telecommunications fell 2.7%, 7.6%, 13.4% YoY to Rmb4.85bn, Rmb4.46bn, and Rmb1.86bn in 1H23; meanwhile, revenue from gas transmission and others1 rose 18.6% and 36.2% YoY to Rmb237mn and Rmb828mn. The number of distributors rose 100 HoH to 2,806.
　　3） Steady growth of other products: In 1H23, revenue from the building materials and home improvement business, environmental protection business, and overseas shopping malls grew 10%, 22%, and 20% YoY to Rmb1.34bn, Rmb176mn, and Rmb579mn. Revenue from the photovoltaic （PV） segment rapidly ramped up to Rmb739mn.
　　4） GM recovered amid falling raw material prices: In 1H23, prices of raw materials such as PVC fell sharply YoY, driving GM of pipes up 3.6ppt YoY to 30%, but gross profit per tonne fell Rmb133/t YoY. Blended GM rose 1.4ppt YoY to 27.8% in 1H23, driving gross profit up 8% YoY to　Rmb4.26bn.
　　Expenses edged up; gearing ratio rose. In 1H23, selling and G&A expenses rose 9.7% and 7% YoY, while other expenses declined 28% YoY, driving EBIT up 31% YoY to Rmb2.44bn. The firm's accounts receivable days increased by three days YoY to 59 days, and its accounts payable days rose 11 days YoY to 140 days. In 1H23, total debts grew Rmb2.7bn HoH to Rmb22.8bn, while cash remained largely unchanged HoH. Net gearing ratio rose about 10ppt to 66.8% as the firm increased capex and new businesses needed funding support.
　　Trends to watch
　　Main business resilient; watch demand recovery. Looking ahead, we expect demand to recover slowly in 2H23. We think the profitability of the firm's main business will remain stable thanks to its advantages in distribution channels, costs, and diversified product categories, thereby supporting steady profit growth. If demand from real estate and municipal services recovers, we expect the firm's revenue and profit growth to pick up. The firm's dividend payout ratio has reached 30% and its valuation stands at only 4x P/E, implying an attractive dividend yield.
　　Financials and valuation
　　Due to weak demand, we cut our 2023 and 2024 net profit forecasts 15% and 17% to Rmb3.0bn and Rmb3.36bn. The stock is trading at 4x 2023 and 3.4x 2024e P/E. We maintain an OUTPERFORM rating. Given higher risk appetite in the Hong Kong stock market, we cut our target price 45% to HK$5.5, implying 5.1x 2023e and 4.3x 2024e P/E, offering 28% upside.
　　Risks
　　Disappointing downstream demand and/or business expansion.