May 7 (Bloomberg) -- Arcelor SA, the world's largest steelmaker, may say Monday that first-quarter earnings rose 8 percent as steel prices at the highest level since 1995 made up for a surge in raw-material costs spurred by China's expansion.

Profit probably climbed to 208 million euros ($253 million) from 192 million euros, based on the median estimate of eight analysts surveyed by Bloomberg. Luxembourg-based Arcelor boosted prices for flat carbon steel, used to make cars and appliances, by 7 percent in January and 8 percent last month.

Arcelor may find it more difficult to raise prices again as China tries to cool its economy, said investors including Cesar Perez in London. The government last week clamped down on lending to some industries, including steel. Chinese steel demand may grow 13 percent this year, down from 25 percent in 2003, the International Iron and Steel Institute in Brussels estimates.

``The key issue here is the sustainability of prices going higher,'' said Perez, who manages a $400 million fund that has been selling Arcelor shares at M&G Group Plc. ``One of the big question marks is China.''

Chinese steelmakers including Baoshan Iron & Steel Co. are still adding capacity, after increasing output by a fifth last year to 220 million metric tons. Perez's fund has been buying shares in Acerinox SA of Spain, the world's third-largest maker of stainless steel, where China has been slower to expand.

Rising Costs

Arcelor, and European rivals ThyssenKrupp AG and Corus Group Plc, want to raise steel prices next quarter to cover costs of iron ore and coking coal that have jumped about a fifth this year. Global steel production this year probably will exceed 1 billion tons for the first time, according to the steel institute.

Arcelor makes most of its steel in Europe, where it employs about four-fifths of its workforce and gets three-quarters of sales. Chief Executive Guy Dolle, 61, is investing in countries including Brazil, where production costs are about a fifth lower. Arcelor has 500 million euros a year to spend on ``external growth,'' Dolle said in March.

``In the medium term, they need to get more production assets outside Europe, in lower-cost locations,'' said James Ravine, a credit analyst at Barclays Capital in London. ``If the investment is half a billion this year, that's comfortably manageable within the context of the cash flow we expect them to generate.''

Arcelor's price increases don't all show up as profit. More than half of the company's flat carbon steel is shipped on multiyear contracts. Unless Arcelor can boost prices on shorter contracts, rising costs may narrow margins, UBS AG said in a note last week.

``We would like to understand how the group intends to deal with this strategy going forward,'' analysts Michael Shillaker, Emmanuel Androulakis and Michael Cook said in the note.

Debt

Arcelor's debt probably fell to 4.1 billion euros in the quarter from 4.46 billion euros three months earlier after the company paid off bonds before they matured, UBS said. It rates the shares ``Buy 1.''

The company said in February it planned to cut debt by at least 500 million euros this year, after slashing it by 1.5 billion euros in 2003. Arcelor's debt is rated BBB by Standard & Poor's, investment grade and higher than rivals Corus or ThyssenKrupp.

The cost of insuring Arcelor debt using credit-default swaps has plunged in the past year, according to Morgan Stanley prices on Bloomberg. It costs 69,500 euros a year to cover 10 million euros of debt for five years, down from as much as 130,000 euros.

The lower debt and rising steel prices helped Arcelor shares gain 6.8 percent in the quarter. London-based Corus, the U.K.'s largest steelmaker, surged 38 percent as it recovered from near- bankruptcy. ThyssenKrupp of Germany, the world's biggest maker of stainless steel, fell 5.7 percent.

Arcelor was formed in 2002 from the merger of Usinor SA of France, Arbed SA of Luxembourg and Aceralia Corporacion Siderurgica SA of Spain. Dolle, who joined Usinor in 1980, was paid 832,500 euros last year.

Freight Rates

Cheaper steel imports were kept out of Europe in the first quarter by freight rates that tripled from a year earlier. That limit on competition helped Arcelor boost prices even as Europe's steel demand lagged.

EU steel demand rose 0.9 percent last year, less than the global average of 7.3 percent, the steel institute said. It forecast EU demand growth of 2.3 percent this year, still behind the global average of 6.2 percent.

A lack of raw materials is further limiting supply, helping prices. Benchmark export prices for hot-rolled coil from the EU have gained 62 percent this year to $495 a ton, the highest since April 1995, according to Metal Bulletin.

``A few months ago all the talk was of the rapid rate of price increases,'' MEPS (International) Ltd., a U.K.-based consultant, said in a note. ``Now the problem is actual availability.''

To contact the reporter on this story: Stuart Wallace in London swallace6@bloomberg.net.

Last Updated: May 6, 2004 19:06 EDT