Gathering momentum. BUY Target Price: HK$2.70 (+37%) Price: HK$1.97 HKEx Code: 206 Mon, 28 Mar Result Update. Key points:

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1 Mar-10 May-10. Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 TSC Group (TSC 集團 ) BUY Target Price: HK$2.70 (+37%) Price: HK$1.97 HKEx Code: 206 Mon, 28 Mar 2011 Gathering momentum Equity Research Oil & Gas equip/ China Key Data Result Update Close price (HK$) Months High (HK$) Month Low (HK$) M Avg Dail Vol. (mn) 1.27 Issue Share (mn) Market Cap (HK$mn) 1, Free Float % Net cash/share (HK$) 0.02 Net debt/equity (%) Net Cash Fiscal Year 12/2010 Major shareholder (s) Brian Chang & Asso. (16.6%) Source: Company data, Bloomberg, OP Research Closing price are as of 25/3/2011 All figures are subject to rounding Price Chart 206 HK MSCI CHINA % Key points: FY10 result beat estimate. TSC s FY10 revenue rose 27% yoy to US$143mn with a net profit of US$13.6mn (FY09: US$10mn loss). The topline and bottomline were 9% & 97% above our estimates respectively. Topline growth was driven by completion of rig turnkey solutions as well as stronger-than-expected contribution from expendables and engineering. Gross margin expanded to 36.4% from 18.8% in FY09 and is 2.5% higher than our estimate of 33.9%. Margin expanded as the company was no longer burdened by the low-margin legacy GME orders as in FY09 and also as production costs fell at a faster-than-expected pace with the shift to mainland China. Income tax rate, at 9.7%, was lower than our estimate of 30% as the company utilized tax losses. The ascent begins. With healthy crude oil price level and the assimilation of GME behind it, we think TSC is now ready to expand its global market share by offering globally competitive products at China speed and cost. During the analyst meeting, management expressed strong confidence to win significant new orders this year. We are positive about TSC s prospect in light of its 1) strengthened global selling, marketing and service network; 2) stronger international management team; and 3) enhanced operational efficiency. Recommend BUY. With higher gross margin estimate at 35.1% (originally 32.2%), we raise our FY11 net profit estimate by 12.0% to US$15mn, representing 13% yoy growth, followed by 50% growth in FY12 to US$23mn. The stock is trading at 11x FY11E PE, we recommend BUY with TP raised to HK$2.70, based on 15x FY11E PE, or 0.33x PEG, offering 37% upside. (Risk: Failure to win major new order). Company Background The Group is principally engaged in manufacturing and trading of rig equipment, delivery packaged equipment to offshore rigs, provision of consultancy services. Eric Kwok Oriental Patron Securities Ltd eric.kwok@oriental-patron.com.hk Exhibit 1: Investment Summary (US$mn) FY09A FY10A FY11E FY12E FY13E Revenue (mn) Growth (%) (30) Net Income (mn) (10) Growth (%) (199) na Gross margin (%) Profit margin (%) (9.0) ROE (%) (8.8) ROA (%) (5.2) EPS (0.12) P/E (x) (16.2) P/B (x) Source: Bloomberg, OP Research

2 Exhibit 2: FY10 result vs estimate US$mn FY10A FY10E Diff % Note Revenue % Expendable & engineering revenue US$14mn above estimate Gross profit % Topline & GM above estimate Profit before tax % Income tax (1) (3) -53% Recognition of US$1.9mn unused tax losses Net profit % Gross margin 36.4% 33.9% 2.5% Effective cost reduction moving to PRC Net margin 9.5% 5.30% 4.2% Source: Company, OP Research Segment performance. Revenue of rig turnkey solution segment increased 265% yoy to US$52mn with progress in projects delayed in FY09 and with the speedy delivery of the Dragon Oil project (90% equipment delivered). As a result, segment operating profit rose by ~600% to US$26mn. This compensated the 29% yoy drop in revenue of rig product & technology segment, which continued to post operating loss of US$14mn. Contribution from expendables and engineering service segments grew by 91% and 107% yoy with increased global coverage, improved customer recognition and additional revenue brought in through the Jurun acquisition in Sep As a result, operating profit from these two segments increased by more than 500% to ~US$9mn. Gross margin improvement. The strong gross margin recovery from 18.8% in FY09 to 36.4% is a proof that TSC is completing the assimilation of GME (now called TSC UK), which depressed FY09 margin as a result of low-margin legacy orders. We noted that FY10 gross margin was inflated by a one-time contract renegotiation with CIMC Yantai Raffles Offshre in 1H10, which boosted the operating margin of turnkey solution segment to an abnormal level of 67%. Nevertheless, the undistorted 2H10 gross margin of 36.1% was above our estimate due to faster-than-expected pace of cost reduction as TSC shifted production to mainland China. Other positive developments. We also noted the following positive developments: Strengthened global selling, marketing and service network. The company has opened offices in Brazil, Mexic, Saudi Arabia, among others, thus enhancing its capability to reach and serve global customers. Stronger international management team. During the year, TSC added two key management with strong industry background: 1) Mr. Roger Lewis, executive VP, used to be a senior management of Noble Corporation, a leading offshore drilling contractor, where he spent 29 years. 2) Dr. Sun Yuanhui, VP of engineering and chief technology officer. Dr. Sun is also an industry veteran and held various technical and management positions in Noble. The fact that TSC was able to attract these international talents is a vote of confidence in the future of TSC, we think. Enhanced operation and internal control. Management implemented a series of measures to improve cost control and production and delivery process over its global operation. Reduced reliance on Yantai Raffles. Instead of relying on Yantai Raffles to bring in orders, TSC was responsible for the selling and marketing efforts that led to the Dragon Oil turnkey solution order. Management is confident of winning future orders without participation from Yantai Raffles. 28 March 2011 Page 2 of 6

3 Favorable crude oil price. With crude oil price hovering around US$100/barrel recently, well-above the sustainable US$70-80/barrel level, management anticipates positive demand growth barring major accidents. Focus on winning new order and market share. The assimilation of GME has absorbed considerable management energy in the past two years. Now with the assimilation largely complete, the company is turning its focus to win new orders. During the post-result analyst meeting, management expressed strong confidence in winning significant new orders this year. We believe the announcement of major new order will be a catalyst for share price. Unsatisfactory order book at year end. TSC s order book was US$85mn, 12% below our estimate of US$97mn. This is even after including the US$28mn order book brought in through the acquisition of Junrun in Sep We also noted that the US$28mn had a duration of 4-5 years, longer than the normal 6-18 months duration of TSC s order book. As such, we anticipate a relatively weak 1H10 result, to be compensated by strong 2H10 result with the expected new order mentioned above. However, if the company failed to win major new order as guided, our estimate will need to be revised. Time is TSC s friend. We are positive about TSC gaining market share in the global market in the long run. As explained in our previous reports, TSC is one of the only three global players with the ability to offer total solution package for offshore rigs. Although it is currently much smaller than NOV and Aker Solutions, the two industry leaders, we think TSC is poised to gain market share as it is capable of offering globally competitive products at China speed and cost. Warren Buffett said that Time is the friend of the wonderful company, the enemy of the mediocre. In TSC s case, we believe time is its friend. Exhibit 3: Estimate changes US$mn FY11E old FY11E new Change Note Revenue % Lower year end order book Cost of sales (120) (112) -7% Gross profit % GM estimate 2.9% higher Other income & expense - net (1) (1) 0% Selling and distribution costs (7) (7) 0% Administrative expenses (28) (32) 16% Operating profit % Finance costs (1) (1) -5% Profit before income tax % Income tax expense (6) (4) -36% Lower tax rate with planning Net profit % Source: Company, OP Research 28 March 2011 Page 3 of 6

4 Financials Exhibit 4: Income Statement Year ended Dec (USDm) FY09A FY10A FY11E FY12E FY13E Revenue Cost of sales (92) (91) (112) (153) (205) Gross profit Other income & expense - net (8) (2) (1) (2) (2) Selling and distribution costs (5) (6) (7) (9) (13) Administrative expenses (23) (28) (32) (43) (57) Operating profit (14) Profit/(loss) of associates Finance costs (1) (1) (1) (1) (2) Profit before income tax (14) Income tax expense 4 (1) (4) (6) (8) Net profit (10) Exhibit 5: Balance Sheet Year ended Dec (USDm) FY09A FY10A FY11E FY12E FY13E Property, plant and equipment Property under development Interest in leasehold land held for own use under operating leases Goodwill Intangible assets Interest in associates Deferred tax assets Non-current assets Inventories Trade receivables Others Pledged bank deposits Cash and cash equivalents Current assets Trade payables Bank borrowings Others Current liabilities Bank borrowings Others Non-current liabilities Net assets EQUITY March 2011 Page 4 of 6

5 Exhibit 6: Cashflow Statement Year ended Dec (USDm) FY09A FY10A FY11E FY12E FY13E Profit before tax (14) Share of profit of associates (1) (0) (0) (0) (0) Depreciation & Amortization Other adjustments 3 8 (1) Operating cash flow before change in WC (7) Changes in working capital (7) (35) (18) (32) (38) Cash generated from operations (13) (2) Finance income/(expense) (1) (1) (1) (1) (2) Income tax paid (1) (1) (4) (6) (8) Net cash generated from operating activities (15) (4) CAPEX (5) (15) (13) (21) (28) M&A - (4) (0) (0) (0) Others (1) Net cash used in investing activities (5) (14) (10) (12) (18) Share capital raised Increase/(decrease) in bank borrowing 15 (8) Dividend paid Others (2) Net cash generated from/(used in) financing 42 (3) activities Net increase/(decrease) in cash and cash 22 (21) equivalents Exhibit 7: Ratios Year ended Dec (USDm) FY09A FY10A FY11E FY12E FY12E Growth (%) Revenue (30) EBIT (198) na Net profit (199) (233) EPS (170) (230) Profitability (%) Gross margin Net margin (9.0) ROA (5.2) ROE (8.8) Leverage (%) Total liabilities / assets Total liabilities / equity Net debt (cash) / equity (9) Working capital Current ratio Days of inventory Days of trade receivables Days of trade payables March 2011 Page 5 of 6

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