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UPDATE 2-China's Baosteel disappoints despite red-hot demand

(Adds details, analysts' comments)

By Edwin Chan

SHANGHAI, Oct 31 (Reuters) - Top Chinese steel maker Baosteel disappointed on Friday with an 18 percent jump in quarterly profit after a surprise charge, but analysts said sizzling car and construction demand will fire up earnings in the last quarter.

Baosteel , which vies with Japan's Nippon Steel Corp and Korea's POSCO to supply an economy that grew 9.1 percent in the year to the third quarter, enjoyed resilient steel prices and a heavier focus on supplying high-end plates for cars.

Analysts had scrambled to upgrade their forecasts in the month leading up to the results announcement.

But the world's fourth-most-valuable steel player decided to halve depreciation periods on transport equipment -- such as forklifts and trucks -- to five years from 10 years, eroding net earnings by 287 million yuan in the third quarter, it said.

Nonetheless, analysts said Baosteel was well placed to profit from roaring domestic demand because it and parent Baosteel Corp supply about 11 percent of the country's steel.

Steel demand has surged more than 20 percent in the past two years and is expected to forge ahead at the same pace in 2003, spurred largely by a building spree that is transforming parts of cities into permanent construction sites.

"Baosteel's fourth quarter should climb more strongly as it has already fixed prices in its order book, and those that we have seen were higher than in the third," said industry analyst Zhang Lei at Merchants Securities.

"We're sticking to our prediction that 2003 profit will exceed seven billion yuan, even with faster depreciation."

Baoshan Iron and Steel Co Ltd earned 1.52 billion yuan ($183.7 million) in the third quarter. That compared with 1.29 billion yuan a year earlier, it said in a report on the Shanghai stock exchange's Web site, www.sse.com.cn.

Baosteel's net profits have lagged its peers in the third quarter. POSCO's third-quarter net profit jumped 32 percent while Taiwan's China Steep Corp saw earnings nearly double.

Its yuan-denominated A shares -- open to local and select foreign investors -- fell 1.3 percent to 5.94 yuan by midday, vastly underperforming the market's rise. But they are up 44 percent so far in 2003, outperforming a flat index.

PRICIER THAN POSCO

Baosteel now ranks fourth in terms of market capitalisation at $9.1 billion among the world's steel makers -- behind only Nippon Steel, Japan's JFE Holdings and POSCO.

But at 11.6 times forecast earnings, Baosteel's stock is more than twice as expensive as POSCO's 6.3 times and about level with Europe's Arcelor , the world's top steel maker by output.

Its nine-month net profit more than doubled to 5.32 billion yuan from 2.64 billion yuan in the same period of last year, as turnover jumped 37 percent to 32.56 billion yuan.

"Our company forecasts 2003 net earnings will climb more than 50 percent because overall steel prices are expected to grow sharply in 2003 versus last year," Baosteel said.

If the extra depreciation charge was excluded, Baosteel's quarterly earnings would meet five analysts' consensus forecast for 1.84 billion yuan in earnings, a 43 percent increase on a year ago.

Baosteel also said it would take depreciation charges of 267 million yuan in the fourth quarter, on top of usual costs.

"We discovered during a routine examination that the depreciation lifespans for certain assets were inappropriate," Baosteel said to explain the charge. It did not elaborate.

Still, analysts reaffirmed views that profits for 2003 would surpass seven billion yuan, versus 4.27 billion yuan in 2002.

But they warned that ballooning inventories in the country's car sector and government steps to cool the steel industry could weigh on earnings in 2004.

A shift to supplying advanced steel plates for cars helped profit margins race past 30 percent for the first nine months.

But with China increasingly a focus for global auto makers escaping depressed or saturated home markets, a rush of investment has generated billions of dollars of unsold inventory, indicating a possible margin-eroding price war in coming years.

"Steel prices have neared a peak," said Liu Zechun, an analyst at Tianxiang Investment. "With an earnings base so high this year, we think Baosteel will come under heavy pressure to improve next year." ($1 = 8.276 Yuan)