ORIENTAL YUHONG WATERPROOF(002271)：ENJOYING LEADING POSITION IN PROJECT CHANNEL;RETAIL SECTOR GAINS MOMENTUM

　　Action
　　Despite multiple headwinds in the past two years, Oriental Yuhong Waterproof’s （Oriental Yuhong） channel transformation, which started in 2019, has paid off, in our view. The transformation has enabled the company to maintain solid revenue, high profit margin, and a superior customer structure （the proportion of project and retail channels has risen to 65% from 45% in 2019）。
　　We expect the demand structure to become fragmented and channels to become increasingly important. Oriental Yuhong has created high-quality channel stickiness and a virtuous cycle through its early deployment and comprehensive empowerment of distributors.
　　Reasoning
　　Project channel: Demand structure is changing and channel operation strengthening. We believe demand will be more fragmented, imposing higher requirements on channel strength. The company has completed its process of channel reform and will continue to develop its partnership strategy.
　　Channel flattening: Co-development with many partners through localized operation; penetrating lower-tier markets and developing small- and mid-sized and micro partners.
　　Comprehensive empowerment: Systematic empowerment through standardized construction, project credit, and profit sharing to attract high-quality distributors. In the future, credit will be granted based on individual projects, and payment collection will be strengthened.
　　Market coverage: Inclusion on the government procurement list and joint design and development of differentiated products with design institutes help improve profit margin.
　　We are upbeat on the company’s expansion into the infrastructure market. In addition, we expect the company’s bargaining power to improve and its cash flow and profit margin to increase thanks to the rising proportion of distribution channels.
　　Retail channel: Focus on foremen; product categories expanding. With a focus on foremen, the company has formed a virtuous cycle of high-quality products, excellent channels, and high profits:
　　Quality products: Continue to optimize product mix and quality, and constantly develop new products.
　　Robust channels: Yuhong has trained 700,000 foremen, and continues to secure foremen resources through high-frequency interaction with distributors to generate high retail sales.
　　High profit: Cost advantage strengthened after intensive capacity expansion. Brand effect widens the price range, providing generous profit distribution for all parties.
　　As a result, Oriental Yuhong has continued to increase the number of distribution channels （growing at a CAGR of 50% over the past three years to 180,000）， expand product categories, and leverage synergies between foremen to drive business expansion and dilute expenses. Net margin of civil building materials rose from 11-12% in 2019 to 18% in 2022.
　　Costs: Prices fluctuating more sharply, but profit has substantial upside potential in the long term. Although average prices of asphalt and other chemicals may not return to their previous lows, we expect raw material prices to decline amid global recession and weakening oil prices. We estimate that a US$1/bbl drop in oil prices will translate into a Rmb30-50/t decline in asphalt prices, helping the company lower cost by about Rmb50mn. In addition, we estimate that gross margin in 2023 will rise 3ppt YoY if average prices of asphalt and emulsion fall 10% and 15% in 2023 YoY.
　　Financials and valuation
　　We maintain our 2023 and 2024 earnings forecasts. The stock is trading at 17.4x 2023e and 14.0x 2024e P/E. We maintain an OUTPERFORM rating and our target price of Rmb45, implying 26x 2023e and 21x 2024e P/E, implying 50% upside.
　　Risks
　　Slower-than-expected demand recovery; higher-than-expected raw material prices; disappointing expansion of infrastructure business .
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   【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。