2023 results missing our expectations
　　China Lesso announced its 2023 results: Revenue rose 0.3% YoY to Rmb30.9bn, and attributable net profit fell 6% YoY to Rmb2.37bn. In 2H23, revenue fell 2% YoY to Rmb15.6bn, and attributable net profit dropped 29% YoY to Rmb874mn. The results missed our expectations due to impairment and larger-than-expected growth in financing costs.
　　1) The sales volume of plastic pipes recovered steadily. Full-yearsales volume of plastic pipes rose 11% YoY to 2.65mnt, with polyvinyl chloride (PVC) and non-PVC rising 9% and 14.5% YoY to 1.94mnt and 0.71mnt. Plastic pipe sales volume grew 8% YoY to 1.37mnt in 2H23.
　　2) Product ASP weakened along with falling raw material prices,weighing on pipe product revenue. Due to falling prices of raw materials such as PVC and polypropylene random (PPR), the ASP of the firm's pipe products fell 13% YoY, with the full-year ASP of PVC and non-PVC products falling 18% and 7% YoY. As a result, revenue from PVC products fell 11% YoY to Rmb14bn, and revenue from non-PVC products rose 6.6% YoY to Rmb10.6bn. Together, they fell 4% YoY to Rmb24.6bn. 3) By region & use: Due to falling prices, revenue from overseas plastic piping systems fell 6% YoY to Rmb956mn vs. -11% YoY in southern China to Rmb11.4bn and +3.7% YoY in non-southern China regions to Rmb12.2bn. Revenue from piping systems for drainage, water supply, and power supply fell 5%, 5%, and 11% YoY, while gas transmission and others grew 10% and 35% YoY.
　　4) GM has recovered amid falling raw material prices. The GM ofplastic piping systems rose 1ppt YoY to 28.5% in 2023, with a 3ppt HoH decline to 27% in 2H23 (gross profit per tonne falling Rmb450 HoH to Rmb2,432/t in 2H23).
　　5) Other businesses remained solid and PV sales ramped up.
　　Revenue from building materials and home improvement products rose 5% YoY to Rmb2.8bn, and overseas shopping malls grew 58% YoY to Rmb1.5bn, while revenue from the PV segment reached Rmb1.1bn (+79% YoY).
　　6) Blended GM stable; expenses dragged profit margin. Due to thedrag from non-pipe business (GM down 6ppt YoY to 17.7%), blended GM in 2023 fell 0.5ppt YoY to 26.3% due to increased expenses. The selling and G&A expense ratios rose 0.3ppt and 0.3ppt YoY to 5.1% and 5.4%, while impairment increased Rmb392mn YoY to Rmb858mn, and financial expenses rose Rmb431mn YoY to Rmb1.1bn (implying financing costs up 2ppt YoY to 5.7%). Net margin fell 0.5ppt YoY to 7.7%.
　　7) Accounts receivable fell slightly. Accounts receivable fell Rmb341mnYoY to Rmb4.53bn.
　　8) Interest-bearing liabilities decreased, and its structureimproved. In 2023, interest-bearing liabilities fell Rmb691mn YoY to Rmb19.3bn, with US dollar borrowings down Rmb3bn and HK dollar and renminbi borrowings up Rmb2bn and Rmb1bn.
　　9) The firm declared a final dividend of HK20 cents per share, withpayout ratio down 9.3ppt YoY to 23.7%, implying a dividend yield of about 5.4%.
　　Trends to watch
　　Earnings of pipe business solid; balance sheet and new PV businessimproving. In 2024, we expect industry-wide pipe sales volume to rise steadily, supported by infrastructure construction and municipal projects, and the firm's piping profit margin to remain high. However, to improve the profitability of the PV business, the firm still needs to strengthen cost control.
　　Financials and valuation
　　We cut our 2024 net profit forecast 23% to Rmb2.6bn and introduce a 2025 forecast of Rmb2.8bn, as profit from new businesses drags the firm’s earnings. The stock is trading at 3.9x 2024e and 3.5x 2025e P/E. We cut our target price 18% to HK$4.5, implying 4.7x 2024e and 4.2x 2025e P/E.
　　Considering the company’s earnings stable, we maintain OUTPERFORM rating and offering 21% upside.
　　Risks
　　Disappointing downstream demand and/or business expansion.