1H24 results in line with our expectations
　　China Lesso announced its 1H24 results: Revenue fell 11% YoY to Rmb13.6bn and attributable net profit fell 30% YoY to Rmb1.04bn. The results are largely in line with our expectations.
　　Main pipe business relatively resilient; new businesses under pressure.
　　Sales volume of plastic pipes was relatively resilient. In 1H24, sales volume of plastic pipes fell 6% YoY to 1.2mnt, with sales volume of PVC and non-PVC plastic pipes falling 5% and 6% YoY to 0.89mnt and 0.31mnt. The firm cut product prices due to fiercer competition. The ASP of its pipes fell 3% YoY but rose 4% HoH to Rmb9,330/t (ASP of PVC and non-PVC pipes down 3% and 2% YoY). Revenue from plastic pipes fell 8% YoY to Rmb11.2bn. Gross margin of pipes dropped 0.5ppt YoY to 29.5%, implying that per-tonne gross profit fell Rmb360 YoY to Rmb3,310.
　　Pipe demand from real estate and municipal industries declined, while demand from emerging industries gradually increased. The firm actively transformed its customer base for its pipe products, acquiring new customers such as state-owned enterprises, urban construction companies, and agriculture companies. In 1H24, revenue from pipes for water supply, drainage, power & telecommunications, gas, and others were Rmb4.4bn (-9% YoY), Rmb4.1bn (-7% YoY), Rmb1.6bn (-12% YoY), Rmb200mn (-13% YoY), and Rmb800mn (+0.1% YoY). The number of distributors rose 84 YoY to 2,891.
　　Other businesses were undergoing adjustments. In 1H24, revenue from building materials & home furnishings, environmental protection, supply chain service platform, and photovoltaics were Rmb1.08bn (-19% YoY), Rmb131mn (-26% YoY), Rmb769mn (+33% YoY), and Rmb157mn (-79% YoY). Combined gross margin fell 1.4ppt YoY to 17.8%.
　　Gross margin and expense ratio were under pressure. In 1H24, overall gross margin fell 0.4ppt YoY to 27.5%, and gross profit fell 12.5% YoY to Rmb3.728bn. Selling expenses declined 0.5% YoY, and G&A and other expenses increased 0.5% and 6.8% YoY. Selling and G&A expense ratios rose 0.6ppt and 0.7ppt YoY. Interest expenses declined 8.8% YoY.
　　Attributable net profit fell 30% YoY to Rmb1.04bn, with net margin down 2.1ppt YoY to 7.7%.
　　Turnover days increased; gearing ratio was relatively stable. In 1H24, accounts receivable days rose 4 days YoY to 62 days, and accounts payable days rose 19 days YoY to 159 days. Total debt increased Rmb300mn HoH to Rmb21bn (USD and HKD borrowings as a percentage of total borrowings fell 3.7ppt HoH to 49.5%). Cash on hand remained largely unchanged HoH. Net gearing ratio rose about 2ppt HoH to 60%.
　　Trends to watch
　　Main business resilient; waiting for demand recovery; watching debt adjustment. We expect demand to remain under pressure in 2H24. We think gross margin of the main pipe business is likely to remain stable thanks to the firm’s exploration of new areas, distribution channel advantages, and cost advantages. If demand from real estate and municipal industries recovers, we expect the firm’s profitability to gradually pick up. At present, the firm’s debt ratio is relatively high, and it is actively changing currencies of its liabilities, selling overseas assets and reducing foreign-currency liabilities.
　　Financials and valuation
　　Considering weak demand, we cut our 2024 and 2025 net profit forecasts 21% and 23% to Rmb2bn and Rmb2.2bn. The stock is trading at 3.8x 2024e and 3.5x 2025e P/E. Given that the firm is an industry leader, we maintain an OUTPERFORM rating. Due to earnings forecast cut and low risk appetite in the Hong Kong stock market, we lower our target price 24% to HK$3.4, implying 4.6x 2024e and 4.3x 2025e P/E and offering 22% upside.
　　Risks
　　Weaker-than-expected downstream demand; disappointing business expansion.