We see several positive drivers on China Lesso: (1) the potential recovery of infrastructure spending and favourable weather should drive higher sales volume growth of plastic pipe in 2H19E; (2) increasing pricing power should continue to enhance gross margin; (3) on-track new business development should offer growth driver over the medium term. While share price gained >100% YTD (mainly driven by significant margin expansion in 1H19), it is still trading at only 7.4x/6.5x 2019E/20E consensus earnings.
- Plastic pipe business: capacity growth and upgrade to drive growth. China Lesso doubled its annual sales volume of plastic pipe between 2012 and 2018. As at end-Jun 2019, the annual capacity of plastic pipe was 2.69mn tonnes. Going forward, China Lesso plans to expand its capacity by 150-200k tonnes annually. Besides, the Company is on-track to upgrade its existing capacity to achieve automation in order to increase the yield rate and reduce labour cost. For overseas market, China Lesso leased a piece of land in Indonesia to build capacity. We expect Southeast Asia will become another growth driver for the Company’s plastic pipe business.
- Potential pickup of construction activities; limited impact on property weakness. China Lesso expects the sales volume growth to improve given the pickup of construction activities following weakness in summer due to heavy rainfall. On the other hand, the potential weakness of property market will not have significant impact on the Company as the customers are the large property developers that are gaining market share. We expect China Lesso to deliver high single digit growth for the full year, versus 6.6% in 1H19.
- Resilient margin to continue on strong pricing power. The economies of scale, nationwide distribution network and well diversified customer portfolio (largest customer accounts for only 2% of total revenue) are the keys to enable China Lesso to maintain strong pricing power. Gross margin was stable at 24-27% in 2010-2018, and further expanded to 28.7% in 1H19. Going forward, we expect the gross margin to remain resilient as the non-PVC product margin continues to improve on better competitive landscape.
