Summary

For the year ended 31 December 2010, the turnover of Chu Kong Pipe was CNY 1,681,473,000, recorded a YoY decrease of 40%. Profit attributable to equity holders was CNY 70,237,000, recorded a YoY decrease of 85%

Turnover of the sales and manufacturing service of LSAW steel pipes amounted to CNY 1,439,500,000 and CNY 35,600,000 respectively, representing a YoY decrease of 28% and 45% respectively. The reason for the decrease in sales of LSAW steel pipes was the decline in international orders resulted from the delay of oil and gas projects globally. The decrease in the revenue from the manufacturing service of LSAW steel pipes was mainly caused by the decline in orders from China Petroleum and Chemical Corporation after its completion of the gas pipeline project near Sichuan Province, China.

Turnover of the sales and manufacturing service of ERW steel pipes amounted to CNY 170,700,000 and CNY 4,700,000 respectively, representing a YoY decrease of 74.5% and 47.3% respectively.

We estimate our 12 months price of Chu Kong Pipe to HK$4.25 with a “BUY” rating, which is equivalent to our expected 9.7x fair 2011PE and implying a 26.5% upside potential. Key assumptions: Chu Kong Pipe records a 30% increase in sales of LSAW steel pipes comparing with 2009 fiscal year and a 20% discount to the peers` average forward P/E.

Company Update

For the year ended 31 December 2010, sales of LSAW steel pipes was the major sources of income for Chu Kong Pipe, accounting for 86% of total turnover; while sales of ERW steel pipes accounted for 10% of the total turnover.

Regarding to geographical segments, China remained the major sources of income for Chu Kong Pipe, accounting for 61% of total turnover. Although recorded a YoY decrease of 28%, sales from China were relatively stable when compared with other countries. Sales from America contributed the most within other countries and the YoY changes of sales from other countries were volatile.

Sales and manufacturing service of LSAW steel pipes enjoyed higher and stable gross profit margin and average selling price. Chu Kong Pipe was benefited it's the cost-plus production model and the advanced manufacturing technology of LSAW steel pipes. Meanwhile, sales and manufacturing service of ERW steel pipes demonstrate a downward trend on gross profit margin and average selling price. It was due to the backward technology in ERW steel pipes manufacturing resulted in a keen competition environment and a dropping-selling price. In 2010, sales of ERW steel pipes recorded a negative gross profit margin. It was because the revenue from the sales could not cover the fixed costs of production.

In 2010, Chu Kong Pipe established a new production line in Panyu, China. This production line is mainly used for the production of steel pipes for infrastructure projects and commenced production in June 2010. Chu Kong Pipe planed to construct two oil and gas LSAW steel pipes production lines with a planned annual capacity of 300,000 tonnes each. These two production lines will be located in Zhuhai and Lianyungang and are expected to be completed by the 4th quarter of 2011 and the 3rd quarter of 2012, respectively. Upon completion of these two production lines in 2012, the annual capacity of oil and gas LSAW steel pipes will be enhanced to 1.6 million tones. Meanwhile, the Zhuhai production lines will be focus on the offshore pipeline projects.

Diversification – Key to turn around

In 2010, Chu Kong Pipe successfully developed deep sea longitudinal steel pipes and is currently the sole manufacturer of the offshore pipe in China. Shortly after the development of deep-sea longitudinal steel pipes, Chu Kong Pipe was awarded 2 offshore pipeline projects. The South China Sea Gas Development Project (Liwan offshore project) consisted of 66,200 tonnes of LSAW Steel Pipes with contract value of CNY 713.1 million. The Husky's Liwan Deep Sea Project consisted of approximately 160,000 meters of LSAW Steel Pipes with contract value of CNY 500 million.

Furthermore, Chu Kong Pipe's new production line in Panyu commenced production in June 2010. With an annual production capacity of 300,000 tons, this production line is mainly used for the production of steel pipes for infrastructure projects. Chu Kong Pipe has already secured orders from the State Grid Corporation of China and expects more orders from State Grid's projects.

With the introduction of offshore pipe and infrastructure pipe, we expected higher demand for Chu Kong Pipe's product and Chu Kong Pipe can turn the 2010 result around in the coming fiscal year.

Global Economic Depression – Major risk in future

Oversea sales have always been the major sources of income for Chu Kong Pipe. In 2007, 2008, 2009 and 2010, oversea sales accounted for 54%, 52%, 62.5% and 39% of the total turnover respectively.

After the U.S. subprime crisis, the world's governments lowered the interest rate and funded the market, aiming to save the economy. However, the the U.S. economy is still weak and the unemployment rates remain high. In Europe, the sovereign debt crisis worsened that a number of EU member states` sovereign ratings had been lowered by rating agencies, resulting in an unstable economy in the EU zone.

We believe that the global economy status will be the major risk factor for Chu Kong Pipe in future and the oversea sales will be the key for the turn around in 2011.

Financial Analysis

Formation of a JV Company

On 13 June 2011, Chu Kong Pipe entered into the agreement with AHQ to establish the JV Company with a total capital of USD106 million and an initial paid-up capital of 25% of the total capital or equivalent in Sandi Riyal (SR100 million, equivalent to approximately USD26.5 million/CNY 171.1 million). The JV Company will be owned 50% by Chu Kong Pipe and 50% by AHQ. Chu Kong Pipe's total investment in the JV company will not excess USD53 million. The JV will be developed in two phases. The first phase is the construction of the LSAW plant with an annual design capacity of 300,000 tons. The second phase is to set up the ERW plant with an annual design capacity of 200,000 tons.

As the agreement was concluded in June 2011, we believe the operation of the JV company will not influence the result of Chu Kong Pipe until 2012 fiscal year. However, due to the enormous initial capital requirement of the JC company (28.5% of cash and bank balance), together will the current expansion plan, we expected there will be financing need for Chu Kong Pipe and the finance costs of Chu Kong Pipe will increase.

Finance Lease Arrangement

On 1 March 2011, Chu Kong Pipe announced that Chu Kong Pipe, as the lessee, had entered into the Finance Lease Arrangement, which Chu Kong Pipe agreed to sell the Equipment to the Lessor at a consideration of CNY160.0 million and the Lessor agreed to lease back to Chu Kong Pipe the Equipment for a total lease payments of approximately CNY187.9 million. Chu Kong Pipe will pay a guarantee deposit of CNY24.0 million and service charge of CNY8.0 million to the Lessor, for a period of 60 months.

We believe that the finance lease arrangement can ease the financing need of Chu Kong Pipe at the expense of increasing finance costs.

Valuation

We estimate our 12 months price of Chu Kong Pipe to HK$4.25 with a “BUY” rating, which is equivalent to our expected 9.7x fair 2011PE and implying a 26.5% upside potential. Key assumptions: Chu Kong Pipe records a 30% increase in sales of LSAW steel pipes comparing with 2009 fiscal year and a 20% discount to the peers` average forward P/E.

Financial Information

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