China's Rising Star In Steel

Baosteel has talent, technology, and capacity. Can it stay on a roll?

Shanghai Baosteel Group Corp., China's premier steelmaker, has led a charmed life. Most of China's heavy industrial companies date from the 1950s or earlier and must cope with outmoded equipment and inconvenient, landlocked locations more suited to national defense than commercial production. Baosteel, by contrast, was founded near Shanghai's port in 1978, the year Deng Xiaoping opened China's economy, and designated by central planners as the steel industry's flagship. That meant China's best managers were put in charge, expensive technology was imported, and the company was allowed to focus on more profitable products, such as cold-rolled steel and hot-rolled galvanized sheets, leaving low-end products to older rivals.

Today, Baosteel is China's biggest steel manufacturer, and the "best in terms of technology, equipment, and management," says Alain Davezac, who oversees international business development at Arcelor, Europe's biggest steelmaker. Adds Thomas J. Usher, chairman of U.S. Steel Corp. (X ): "They're a first-class company."

Baosteel's results tell the story. Last year, sales jumped 48%, to $14 billion, while profits soared 89%, to $1.6 billion. In 2005, it expects sales to grow to $18 billion as production climbs 15%, to 23 million metric tons. And in the wake of agreements with the Chinese partners of General Motors (GM ), Volkswagen, and Nissan (NSANY ) to develop steel products for the automotive market, Baosteel's stock, traded on the Shanghai exchange, surged by more than 70%, compared with a 14% overall gain for Shanghai A-shares. "We have been growing up with China's economy for the past 20 years," says Chairman and President Xie Qihua, a 35-year veteran of the steel industry who has been with Baosteel since its founding.

Like many of China's other national champions, Baosteel is ready to take its place on the global stage. That means finding more partners abroad. Though Baosteel is still controlled by the state, the company in December signed a deal with Arcelor and Tokyo-based Nippon Steel Corp. to build a $785 million plant in Shanghai. When the plant opens next year, it will provide 1.7 million tons of cold-rolled strips and hot-dipped galvanized steel sheets a year to China's booming auto industry. Joining with international steelmakers "allows us to learn more about new steel products and technology," says Xie. "We are always eager to keep up."

CHALLENGES TO MEET. Keeping up may get tougher this year. Like the rest of China's steel industry, the company must grapple with rapidly rising costs. Shipping rates for iron ore from overseas quadrupled in 2003, while the price of ore jumped by 9% in 2003, with another 10% to 20% rise expected this year. Demand is so high that ore shortages are certain to emerge by midyear, say analysts. Baosteel's solution: make long-term deals abroad. In November, it agreed to triple purchases of iron ore from Brazilian mining company CVRD to 20 million tons annually by 2010. And in 2002, Baosteel paid Rio Tinto (RTP ) PLC's Hamersley Iron unit $30 million for a 46% stake in an Australian iron mine. In addition, the company has trumped other steelmakers by signing deals with domestic coal suppliers guaranteeing delivery at relatively low prices.

A bigger issue for Baosteel is growing competition. From 2001 to 2005, the number of companies in China making flat-rolled steel will nearly double, to 25, according to consultant Accenture Ltd. (ACN ). China has some 4,000 steelmakers, and capacity has grown more than 20% annually for the past two years, says Luo Wei, an analyst at Beijing investment bank China International Capital Corp. Last year China became the world's largest producer of steel, churning out more than 200 million tons.

Much of this growth has been driven by small private companies that have lower overhead costs than Baosteel and no pension liabilities. Shanghai-based Fosun Group -- a real estate, telecom, and medical products conglomerate that began investing in steel in 2001 -- is expanding its steel production in Nanjing and Hebei province, with a goal of reaching 18 million tons annually by 2006. Upstart steelmaker Jiangsu Shagang Group Co. plans to triple its production of everything from wire rods to stainless steel sheets to 18 million tons annually over the next three years. And traditional steelmakers such as Wuhan Iron & Steel Group are going head to head with Baosteel to supply the profitable appliance and auto markets. Wuhan plans to raise as much as $1 billion with an additional listing of shares in Shanghai, part of which will go toward adding 1.8 million tons' of cold-rolled steel production capacity.

The competition isn't just homegrown. China's steel imports surged by 50% last year. And even though Beijing on Jan. 13 slapped antidumping tariffs on steel from certain companies in Korea, Russia, Taiwan, and elsewhere, analysts say imports will still grow by 20% this year. Some foreigners are even building their own mills on the mainland. South Korea's Posco (PKX ), which isn't affected by the tariffs, has invested $680 million in a dozen facilities in China and is constructing a $130 million plant in Qingdao that will produce 140,000 tons of stainless-steel coils by yearend. Posco's joint-venture execs have approved additional investments of $1.4 billion in the country. "With China consuming a quarter of the world's steel, we must be competitive in the market," says Lee Myung Ho, a senior manager at Posco-China Holding Corp.

FORGING AHEAD. As more newcomers join the fray, prices could take a tumble. Concerned that the economy may be overheating, Beijing has already stepped in to brake growth in real estate investment and car manufacturing. If those measures bite and economic growth begins to slow, it would be difficult for steelmakers to sell all of their production. "Overcapacity is already a fact," says Yong Zhiqiang, an analyst at Haitong Securities Co. in Shanghai.

Even Baosteel officials concede that the fat times may be nearing an end. While the company expects continued growth in revenues, profits are likely to remain flat for the next couple of years, says Xie. Still, the steelmaker isn't lowering its sights. In December, it delivered the first batch of pipe to the 4,200-kilometer West-East Natural Gas Pipeline, which is tapping Baosteel for 60% of its steel needs. And a tougher economy could create an opening for Baosteel to snap up smaller rivals in China. Xie, meanwhile, says the company might make more investments abroad, and Baosteel is again considering an international stock listing, something managers planned several years ago but delayed because of the poor initial public offering market. When that share sale takes place, don't be surprised to see foreign investors jump in. After all, as China grows, China's charmed steelmaker will likely grow with it.

By Dexter Roberts in Shanghai, with David Fairlamb in Frankfurt, Michael Arndt in Chicago, and Moon Ihlwan in Seoul

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