China Lesso [2128.HK] Although PVC prices have surged 21% in the past two months, we understand that China Lesso has lifted its ASP a few times since September, which should largely offset the impact of higher raw material costs. Meanwhile, thanks to the government s support for infrastructure projects and PPP (public-private partnership) projects, the Company feels comfortable in achieving >10% volume growth in 2016. Through cooperation with Shanghai Safbon Water Service (300262.CH), China Lesso is well positioned to win more PPP projects in the future. We raised our 2016E/2017E EPS by 3.6%/4.5%, as we revised upwards our 2016E/2017E gross profit per tonne for 2016E/2017E by about 2% each year to reflect stronger demand. After rolling forward the base year from 2016 to 2017, we lifted our target price from HK$5.90 to HK$6.60, based on 8x 2017E PER (6-year average, methodology unchanged). Reiterate BUY. Investment Highlights Demand Remains Solid in 2H16; Cost Hikes Offset by Higher ASP Sharp increase in PVC costs manageable. PVC prices have risen 21% since early September. China Lesso believes the impact is manageable, as it has lifted its ASP a few times in the past two months; there may be a short-term impact on the gross margin, however, because of the time lag between cost hikes and ASP increases. Meanwhile, we found that the China Plastic Pipe Industry Association has raised its guidance prices for PVC pipes by 17%-19% in the past two months. Infrastructure and PPP projects to support demand. The Company said that visibility for demand from the property sector is limited at the moment but that demand from infrastructure and PPP projects, including sponge city projects, remains strong. Therefore, management expects volume growth of >10% to be achievable. Unlikely to repeat a negative earnings surprise in 2H16. China Lesso reported a recurring net profit decline of 5% for 2H15, which led to a de-rating early this year. However, we believe the risk of disappointment is much smaller in 2H16. On the back of stronger demand this year, the sales rebates offered by the Company are likely to be smaller, so margin pressure will be lower. We are projecting a gross margin of 26% for 2H16E, up from 24.7% in 2H15. In addition, some A-share listed plastic pipe companies have released encouraging Q3 results or positive profit alerts, including Weixing New Building Materials (002372.CH; 36% net profit growth in Q3) and Fujian Superpipe (300198.CH; issued a positive profit alert for Q3). Gradually moving to offering a full range of services. Early this month, China Lesso subscribed for 6.8% of the new shares of Shanghai Safbon Water Service for a consideration of RMB500m. China Lesso will appoint a representative to the board of directors of Safbon Water. Through overseas acquisitions in Europe, Safbon Water has expertise in desalination and sewage treatment. In the future, by working with Safbon Water, China Lesso will be not only a plastic pipe supplier but also a full service provider of water/sewage treatment related infrastructure and PPP projects. This will increase China Lesso s chances of winning new projects. Management expects the benefits to be more visible starting in 2018. China Construction Sector BUY Close: HK$5.67 (Oct 25, 2015) Target Price: HK$6.60 (+16.4%) Price Performance (HK$) 8 6 4 2 Market Cap US$2,268m Shares Outstanding 3,102m Auditor Ernst & Young Free Float 31.45% 52W range 3M average daily T/O Major Shareholding October 26, 2016 0 0 Oct15 Dec15 Feb16 Apr16 Jun16 Aug16 Oct16 Turnover (RHS) Price (LHS) Sources: Company, Bloomberg HK$3.8-6.75 US$3.03m Wong Luen Hei (68.36%) Wong Chi Man Head of Research (852) 3698 6317 (HK$ million) 150 100 50 Source: Bloomberg Y/E Dec 31 2012 2013 2014 2015 2016E 2017E Turnover (RMB m) 10,891 13,071 14,823 15,264 17,121 19,958 Recurring net profit (RMB m) 1,219 1,405 1,653 1,736 2,047 2,242 Net margin (%) 11.2 10.8 11.2 11.4 11.9 11.2 Recurring EPS (RMB) 0.40 0.46 0.53 0.56 0.66 0.72 % Change 2 14 16 5 18 10 PER (x) 11.5 9.8 8.4 8.4 7.4 7.1 PBR (x) 2.5 2.1 1.8 1.6 1.3 1.1 EV/EBITDA (x) 8.0 6.6 5.9 5.4 4.5 4.1 Sources: Company, CGIS Research cmwong@chinastock.com.hk Livy Lyu Research Assistant (852) 3698 6393 livylyu@chinastock.com.hk 1
Key financials China Lesso (02128.HK) Income Statement (RMB'000, except for per share amount) 2014 2015 2016E Year ended 31 Dec 1H 2H 1H 2H 1H (A) 2H 2013 2014 2015 2016E 2017E PVC pipes 3,997,803 4,821,458 4,206,892 4,618,389 4,379,253 5,960,891 8,048,970 8,819,261 8,825,281 10,340,145 12,190,139 Non-PVC pipes 2,128,008 2,785,958 2,150,031 2,627,094 2,225,967 2,991,646 4,166,130 4,913,966 4,777,125 5,217,614 5,997,273 Others 455,240 634,305 686,259 975,736 719,895 843,846 855,447 1,089,545 1,661,995 1,563,741 1,770,338 Revenue 6,581,051 8,241,721 7,043,182 8,221,219 7,325,116 9,796,384 13,070,547 14,822,772 15,264,401 17,121,500 19,957,751 COGS (4,938,032) (6,084,006) (5,135,575) (6,191,255) (5,141,630) (7,252,846) (9,804,979) (11,022,038) (11,326,830) (12,394,476) (14,691,188) Gross profit 1,643,019 2,157,715 1,907,607 2,029,964 2,183,486 2,543,538 3,265,568 3,800,734 3,937,571 4,727,024 5,266,563 Operating expenses (784,503) (1,046,303) (868,798) (923,291) (984,534) (1,155,973) (1,502,919) (1,830,806) (1,792,089) (2,140,507) (2,478,259) Operating profit 858,516 1,111,412 1,038,809 1,106,673 1,198,952 1,387,565 1,762,649 1,969,928 2,145,482 2,586,517 2,788,304 Other income and gains 31,754 47,984 22,727 24,779 17,941 19,593 88,399 79,738 47,506 37,534 39,916 EBIT 890,270 1,159,396 1,061,536 1,131,452 1,216,893 1,407,158 1,851,048 2,049,666 2,192,988 2,624,051 2,828,219 Net finance costs (67,885) (36,038) (12,813) (2,089) (16,614) (10,836) (127,936) (103,923) (14,902) (27,450) (27,079) Profits from associates and JCEs 202 196 612 489 385 350 390 398 1,101 735 1,000 Non-recurrent items (61,365) (37,983) (14,087) (100,429) (17,044) - 44,009 (99,348) (114,516) (17,044) - Income before tax 761,222 1,085,571 1,035,248 1,029,423 1,183,620 1,396,671 1,767,511 1,846,793 2,064,671 2,580,291 2,802,141 Income tax expense (139,556) (166,879) (232,919) (213,302) (275,185) (279,334) (329,895) (306,435) (446,221) (554,519) (560,428) Minority interests 5,869 7,797 3,616 (949) 3,945-11,645 13,666 2,667 3,945 - Net income 627,535 926,489 805,945 815,172 912,380 1,117,337 1,449,261 1,554,024 1,621,117 2,029,717 2,241,712 Recurring net income 688,900 964,472 820,032 915,601 929,424 1,117,337 1,405,252 1,653,372 1,735,633 2,046,761 2,241,712 EPS (RMB) 0.202 0.298 0.259 0.262 0.294 0.360 0.471 0.500 0.521 0.654 0.723 Recurring EPS (RMB) 0.221 0.310 0.264 0.294 0.300 0.360 0.457 0.532 0.558 0.660 0.723 DPS (HK$) - 0.130-0.130-0.152 0.120 0.130 0.130 0.152 0.160 Depreciation and amortization 203,992 235,788 242,007 259,108 286,258 306,833 360,338 439,780 501,115 593,091 701,048 EBITDA 1,094,464 1,395,380 1,304,155 1,391,049 1,503,536 1,714,341 2,211,776 2,489,844 2,695,204 3,217,877 3,530,268 Sales volume (tonnes) 643,018 788,621 692,254 849,700 768,611 926,989 1,272,631 1,431,639 1,541,954 1,695,600 1,864,800 PVC 508,691 617,220 560,172 680,728 626,413 741,591 1,003,362 1,125,911 1,240,900 1,368,004 1,500,325 Non-PVC 134,327 171,401 132,082 168,972 142,198 185,398 269,269 305,728 301,054 327,596 364,475 ASP per tonne (RMB) 9,527 9,647 9,183 8,526 8,593 9,658 9,598 9,593 8,821 9,175 9,753 PVC 7,859 7,812 7,510 6,784 6,991 8,038 8,022 7,833 7,112 7,559 8,125 Non-PVC 15,842 16,254 16,278 15,548 15,654 16,136 15,472 16,073 15,868 15,927 16,455 Cost per tonne (RMB) 7,049 7,002 6,521 6,245 5,902 7,050 7,124 7,023 6,369 6,530 7,071 Gross profit per tonne (RMB) 2,478 2,645 2,662 2,281 2,691 2,607 2,474 2,570 2,452 2,645 2,682 Growth Rates: Revenue 16% 12% 7% 0% 4% 19% 20% 13% 3% 12% 17% EBIT 1% 19% 19% -2% 15% 24% 18% 11% 7% 20% 8% EBITDA 4% 20% 19% 0% 15% 23% 21% 13% 8% 19% 10% Core net income 5% 29% 19% -5% 13% 22% 15% 18% 5% 18% 10% Recurring EPS 3% 28% 19% -5% 14% 22% 14% 16% 5% 18% 10% Margins and Ratios: Gross margin 25.0% 26.2% 27.1% 24.7% 29.8% 26.0% 25.0% 25.6% 25.8% 27.6% 26.4% Net margin 10.4% 11.6% 11.6% 11.1% 12.6% 11.4% 10.7% 11.1% 11.4% 11.9% 11.2% EBIT margin 13.5% 14.1% 15.1% 13.8% 16.6% 14.4% 14.2% 13.8% 14.4% 15.3% 14.2% EBITDA margin 16.6% 16.9% 18.5% 16.9% 20.5% 17.5% 16.9% 16.8% 17.7% 18.8% 17.7% Effective tax rate 17% 15% 22% 19% 23% 20% 19% 16% 20% 21% 20% Sources: Company data, CGIS Research estimates 2
Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 Key financials China Lesso (02128.HK) Balance Sheet (RMB'000, except for per share amount) Statement of Cash Flow As at 31 Dec 2013 2014 2015 2016E 2017E Year ended 31 Dec 2013 2014 2015 2016E 2017E Inventories 2,434,049 2,210,038 2,206,543 2,200,000 2,400,000 Profit before tax 1,767,511 1,846,793 2,064,671 2,580,291 2,802,141 Trade receivables 854,518 1,127,901 1,186,226 1,200,000 1,350,000 Depreciation & Amortization 360,338 439,780 467,568 555,795 662,548 Bills receivable 218,041 216,231 292,648 350,000 400,000 Change in w orking capital (480,951) 393,463 499,615 (66,486) (489,000) Others 702,773 561,760 653,331 764,750 883,750 Others / adjustments (143,436) (43,590) (154,870) (400,974) (447,911) Bank balances and cash 2,189,242 3,198,902 3,893,544 3,838,809 4,478,784 Net operating cash flow 1,503,462 2,636,446 2,876,984 2,668,626 2,527,778 Total current assets 6,398,623 7,314,832 8,232,292 8,353,559 9,512,534 Capex (1,161,586) (1,285,113) (1,013,679) (1,400,000) (1,200,000) PPE, net 4,452,109 5,263,614 6,011,812 6,845,474 7,378,041 Others (558,605) (296,182) (479,340) (730,524) (50,000) Prepaid lease payments 996,690 1,087,126 1,157,926 1,207,926 1,257,926 Net investing cash flow (1,720,191) (1,581,295) (1,493,019) (2,130,524) (1,250,000) Others 450,285 853,956 1,247,093 1,928,352 1,929,352 Total non-current assets 5,899,084 7,204,696 8,416,831 9,981,752 10,565,319 Change in debt 504,749 378,088 60,906 (165,502) (100,000) Dividends (291,809) (295,460) (318,373) (334,160) (448,342) Total assets 12,297,707 14,519,528 16,649,123 18,335,311 20,077,853 Others (72,555) (98,654) (416,916) (93,175) (89,461) Net financing cash flow 140,385 (16,026) (674,383) (592,837) (637,803) Trade payables 861,416 973,387 1,681,582 1,700,000 1,700,000 Other payables 1,252,674 1,564,290 1,525,902 1,600,000 1,600,000 Increase / Decrease in cash 266,917 1,009,660 694,642 (54,735) 639,975 Bank and other borrowings 1,080,092 1,158,729 1,065,502 900,000 800,000 Net cash/(debt) (497,874) 19,068 652,804 763,571 1,503,546 Others 103,638 113,440 104,562 166,356 168,128 Total current liabilities 3,297,820 3,809,846 4,377,548 4,366,356 4,268,128 Finance Ratios Bank and other borrowings 1,607,024 2,021,105 2,175,238 2,175,238 2,175,238 2013 2014 2015 2016E 2017E Others 136,920 138,854 230,885 236,653 241,653 Valuation Total non-current liabilities 1,743,944 2,159,959 2,406,123 2,411,891 2,416,891 PE(x) 9.8 8.4 8.4 7.4 7.1 EPS grow th (%) 14 16 5 18 10 Total liabilities 5,041,764 5,969,805 6,783,671 6,778,247 6,685,019 Yield (%) 2.1 2.3 2.3 2.7 2.8 PEG (x) 0.72 0.51 1.69 0.41 0.74 Shareholders' equity 7,239,738 8,545,459 9,770,885 11,466,442 13,302,211 EV/EBITDA (x) 6.6 5.9 5.4 4.5 4.1 Minority interests 16,205 4,264 94,567 90,622 90,622 PB(x) 2.1 1.8 1.6 1.3 1.1 Sources: Company data, CGIS Research estimates Operational Revenue grow th (%) 20 13 3 12 17 Gross margin (%) 25.0 25.6 25.8 27.6 26.4 Net profit margin (%) 10.7 11.1 11.4 11.9 11.2 Days receivables 29 30 34 32 30 Days payables 26 30 43 50 42 Days inventories 78 77 71 65 57 Current ratio (x) 1.9 1.9 1.9 1.9 2.2 Quick ratio (x) 1.0 1.2 1.2 1.2 1.5 Asset/Equity (x) 1.7 1.7 1.7 1.6 1.5 Net debt/equity (%) 7 Net cash Net cash Net cash Net cash EBITDA interest coverage (x) 17.3 24.0 180.9 117.2 130.4 Core ROE (%) 21.2 20.9 19.0 19.3 18.1 Figure 1: Rolling Forward PER 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 Figure 2: Rolling Forward PBR 4.2 3.7 3.2 2.7 2.2 1.7 1.2 0.7 Rolling forward PER (x) Average +1 Standard deviation -1 Standard deviation Sources: Bloomberg, CGIS Research Rolling forward PBR (x) Average +1 Standard deviation -1 Standard deviation Sources: Bloomberg, CGIS Research 3
Figure 3: Brent crude prices (US$/barrel) USD/barrel USD/barrel 130 130 120 120 110 110 100 100 90 90 80 80 70 70 60 60 50 50 40 40 30 30 Figure 4: PVC prices (RMB/tonne) 7600 yuan/ton yuan/ton 7600 7200 7200 6800 6800 6400 6400 6000 6000 5600 5600 5200 5200 4800 4800 SpotPrice:Crude Oil:UK BrentDTD D ata Source: W ind Info M arketprice (M id):pvc (Calcium Carbide Process):National M arketprice (M id):pvc (Ethylene Process):National D ata Source:W ind Info Figure 5: HDPE prices (RMB/tonne) Figure 6: PP prices (RMB/tonne) yuan/ton 12000 12000 11500 11500 11000 11000 10500 10500 10000 10000 9500 9500 9000 9000 8500 8500 M arket Price: HDPE (PetroChina Daqing Petrochem ical 5000S): Guangdong Shunde yuan/ton D ata Source:W ind Info 12000 yuan/ton yuan/ton 12000 11200 11200 10400 10400 9600 9600 8800 8800 8000 8000 7200 7200 6400 6400 5600 5600 31-12-12 31-12-13 31-12-14 31-12-15 Closing Price:SpotG oods:pp Resin (SpotPP) D ata S ource: W ind Info 4
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Explanation on Equity Ratings BUY SELL HOLD : : share price will increase by >20% within 12 months in absolute terms share price will decrease by >20% within 12 months in absolute terms : no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL Copyright Reserved No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited. China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459 Room 3501-3507, 35/F, Cosco Tower, Grand Millennium Plaza, 183 Queen s Road Central, Sheung Wan, Hong Kong. General line: 3698-6888. 5