20140429-Maybank_KERPL-Catalysts_drive_imminent_re-rating_20页_1mb

China Lesso Group Holdings (2128 HK) Summary

Core Content

China Lesso Group Holdings (2128 HK) is a leading manufacturer of plastic pipes and pipe fittings in China, with a strong market position and a diversified business model. The company is currently trading at HKD4.18, with a target price of HKD7.20, offering a 72% upside. Its market capitalization is USD1.7B, with an average daily trading volume of USD2M. The company is listed on the Hang Seng Composite MidCap Index and is considered a key player in the construction materials sector.

Main Points

• Investment Recommendation: BUY
• Valuation Discount: Currently trading at a 40% discount to A-share listed peers and a 20% discount to DCF.
• Earnings Growth: Projected 16% 3-year CAGR in net profit from FY14 to FY16F.
• Dividend Yield: Anticipated to increase to 4%-5% going forward, with a forecast of turning into a net cash position by FY16F.
• Share Price Performance: Positive relative to the index with a 1.1% return over 1 month and 12.3% over 3 months.
• Market Leadership: Ranked as the largest plastic pipe manufacturer in China with FY13 sales four times that of its closest competitor, Yongao.
• Business Expansion: Expanded into the home building materials sector, including sanitary products, kitchen materials, and plastic-steel doors and windows.
• Distribution Model: Relies on 1,780 independent distributors (68% of sales) and direct sales to key clients like Evergrande.

Key Catalysts

• Accelerating Earnings Growth: Expected due to increasing urbanization, government-led infrastructure projects, and demand for plastic pipes.
• Industry Consolidation: Management believes inefficient players will be forced out due to rising costs and environmental regulations, improving industry margins.
• Home Building Business Break-even: Anticipated to reach 12% of total sales by FY16F, with improved gross margin from 15% in FY13 to 20% in FY16F.

Financial Projections

Key Data

• 52-week High/Low (HKD): 5.50 / 3.64
• Free Float (%): 31.1
• Issued Shares (m): 3,089
• Market Cap (HKD): 12.9B
• Major Shareholders:
  • Wong Luen Hei: 68.7%
  • FIL Investment Management (Hong Kong): 1.5%
  • Norges Bank Investment Management: 1.1%

Competitive Landscape

• Industry Fragmentation: Approximately 3,000 manufacturers in China, with only 300 having over 10k tons of capacity and 20 over 100k tons.
• Key Competitors: Yongao (002641 CH), Zhejiang Weixing New Build (002372 CH), Fujian Newchoice Pipe Tech (300198 CH), etc.
• Product Mix: PVC, PE, PP-R, and others. PVC accounts for about 50% of total production, with increasing demand due to government policies and cost considerations.

Valuation and Recommendation

• Target Price: HKD7.20 (72% upside)
• Valuation Multiple: 11X FY14F PER, higher than the 8X for HK-listed peers.
• DCF Value: HKD9.13/share, with a 21% discount from current levels.
• Forward PER Band: 11.0X to 31.42X
• Forward PBR Band: 4.11X to 15.31X

Risk Factors

• Weaker Construction Activity: Could impact demand for plastic pipes.
• Raw Material Cost Volatility: Affects profitability.
• Substitutes: Stainless steel pipes may pose a threat.
• Margin Dilution: From home building materials business.
• Policy Risk: Potential changes in government policies affecting the construction and infrastructure sectors.

Strategic Overview

• Growth Plans: Targeting annual new capacity additions of 80-100k tons by FY16F.
• Geographical Diversification: Sales contribution from Southern China is expected to decline from 60% to 50% in the medium to long run.
• One-stop Shop: Offering consultation, design, and after-sales services to enhance customer value.

R&D and Innovation

• R&D Spending: Increased consistently, with FY13 R&D expenses accounting for 1.9% of sales.
• R&D Focus: Strengthening product quality and technology to maintain competitive advantage.

Market Position and Opportunities

• SWOT Analysis:
  • Strengths: Strong brand recognition, comprehensive product range, and stable management.
  • Opportunities: Government infrastructure projects, migration to plastic pipes, and industry consolidation.
  • Weaknesses: Reliance on third-party distributors, limited presence in Western China.
  • Threats: Austerity in property sector, raw material cost volatility, and substitutes.

Conclusion

China Lesso Group Holdings is positioned to benefit from favorable government policies, increasing urbanization, and industry consolidation. The company's strong market leadership and growth strategies in both core and home building materials segments support a positive outlook. Despite valuation discounts, the projected earnings growth and improving financial metrics suggest a potential re-rating. The BUY recommendation is based on the company's ability to maintain profitability, expand its market share, and leverage its extensive production and distribution network.