We believe that the main reason hindering the rise in the share price of Pearl River Steel Pipe ("Pearl River" or "Group") is the uncertainty of its order, which makes it difficult to predict the profit prospect of the Group. In order to overcome this obstacle and set a reasonable target price for Pearl River steel pipe in the next 12 months, we assume three different sales order conditions through scenario analysis, and further consider the possibility of land sales. Upgrade to "buy" rating.
High degree of uncertainty although we are optimistic about the possibility that demand for oil and gas steel pipes will rebound in 2014, the uncertainty of this forecast is extremely high. Based on our three different scenarios ("ordinary", "pessimistic" and "worst" scenarios), the expected price-to-earnings ratio will range from 4.9 times to 27.6 times. However, when we take into account potential land sales, the Group's valuation is quite attractive, ranging from 2.8 times to 4.4 times.
Taking into account the income from land sales, as the Pearl River Steel Pipe has to pay the domestic land value-added tax after land sales, it is believed that the Group will not be able to turn all the land sales income of 2.01 billion yuan into profits. Assuming a tax rate of 50 per cent, the after-tax profit from land sales will be $1.005 billion or $0.9939 per share. As we have assumed a 50% chance of successful land sales in 2014, only a profit of $502.5 million or $0.4970 per share is included in our valuation.
We fine-tune the assumption of a "normal" scenario in 2014 to reduce our core earnings per share to 0.3974 yuan per share in 2014. We have changed the valuation method of the group's core steel pipe manufacturing business from a price-to-book ratio to a forward price-to-earnings ratio of 11 times (the average of the oil equipment industry). Based on the above factors, we arrive at a target price of HK $3.47 per share, which comes from a valuation of HK $2.84 ($2.244) per share for its core business, plus an expected return of HK $0.629 ($0.497) from land sales. The target price is 40% higher than the current price, raising it to "buy".