August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 1 August 29,2006 COMPANYUPDATE Baoshan Iron & Steel (600019.SS) Interim inline,2H earnings visibility still strong What's changed Baosteel interim at Rmb4,389mn is down 39% yoy,3.6% above our forecast and consensus. Highlights of the result: (1). The 39% yoy earnings fall was driven by an over 20% yoy price decline (hot rolled - HR down 26% yoy and cold rolled-CR down 22% yoy), cushioned by 62% yoy volume growth from a low base (parent asset injection in 1H05). (2). Strong sequential improvement in 2Q with gross margin surging to 24% from 1Q’s 12.6%, consistent with the strong qoq price increase. (HR up 22% qoq and CR up 18% qoq). We see visible improvement in stainless and specialty steel as well. Implications We remain positive on Baosteel due to the combination of strong 2H earnings visibility and trough valuation, against the backdrop of sector’s near term price risk. We believe the current ongoing flat steel product volume ramp up cycle in China plus potential global demand slowdown could pose near term downside risk.2007 supply side dynamics could be better, supported by further signs of favorable capex cycle and entering into the late stage of the volume ramp up cycle in China, in our view. We like Baosteel for its contract price visibility.1H06 realized prices for HR reached Rmb3,369/t (US$415/t, excl. VAT), close to its announced 1H contract average of Rmb3,317/t. The 2H06 contract price (for HR) is 16% higher than 1H, supporting our forecast of a 58% hoh earnings increase. For a 1% asp change, Baosteel’s earnings sensitivity is 6%, more than enough to offset a 19% contract iron ore increase. Valuation Baosteel is trading at 0.8X 2007EPBV, the low end of its PBV trading range, largely factoring in near term sector risk from the strong flat volume ramp up cycle. Our 12- month P/B based target price of Rmb6 is based on mid-cycle PBV of 1.2X, offering potential 44% upside. Key risks Risk include a sharper than expected demand slowdown in 2007, delaying potential flat product cycle recovery. INVESTMENTLISTMEMBERSHIP Asia Pacific Buy List Coverage View: Neutral China: Steel Growth Returns * Multiple Volatility Volatility Multiple Returns * Growth Investment Profile: Baoshan Iron & Steel Low High Percentile 20th 40th 60th 80th 100th * Returns = Return on Capital For a complete description of the investment profile measures please refer to the disclosure section of this document. 600019.SS Asia Pacific Metals & Mining Peer Group Average Key data Current Price (Rmb) 4.18 Price target (Rmb) 6.00 Market cap (Rmb mn / US$ mn) 73,200.2 / 9,177.2 Foreign ownership (%) -- 12/0512/06E 12/07E 12/08E EPS (Rmb) 0.720.650.710.58 EPS growth (%) (3.7) (10.6) 10.4 (19.0) EPS (diluted) (Rmb) 0.720.650.710.58 EPS (basic, pre-ex) (Rmb 0.720.650.710.58 P/E (X) 184.108.40.206.2 P/B (X) 1.00.90.80.8 EV/EBITDA (X) 220.127.116.11.1 Dividend yield (%) 18.104.22.168.2 ROE (%) 21.814.614.911.3 Price performance chart 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 Aug-05 Dec-05 Mar-06 Jun-06 1,100 1,300 1,500 1,700 1,900 2,100 2,300 2,500 Baoshan Iron & Steel (L) Shanghai SEAShare Index (R) Share price performance (%) 3 month 6 month 12 month Absolute (6.7) (3.9) (7.7) Rel. to Shanghai SEAShare Index (8.8) (24.5) (34.5) Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 8/28/2006 close. Song Shen +852-2978-1131 | firstname.lastname@example.org Goldman Sachs (Asia) L.L.C. David Pow +852-2978-1276 | email@example.com Goldman Sachs (Asia) L.L.C. Analysts employed by non-US affiliates are not required to take the NASD/NYSE analyst exam. The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification, see the text preceding the disclosures. For other important disclosures go to /research/hedge.html. The Goldman Sachs Group, Inc. Global Investment Research August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 2 Baoshan Iron & Steel: Summary financials Profit model (Rmb mn) 12/0512/06E 12/07E 12/08EBalance sheet (Rmb mn) 12/0512/06E 12/07E 12/08E Total revenue 126,608.4125,290.9132,528.9132,959.4 Cash & equivalents 4,857.65,252.65,824.86,884.9 Cost of goods sold (99,981.7) (99,890.8) (105,284.4) (108,546.2) Accounts receivable 13,259.48,581.69,077.39,106.8 SG&A (6,701.9) (7,059.5) (7,562.5) (8,066.2) Inventory 25,046.310,946.911,538.014,869.3 R&D -- -- -- -- Other current assets 3,935.18,581.69,077.37,285.4 Other operating profit/(expense) (577.5) (751.0) (794.4) (796.9) Total current assets 47,098.433,362.735,517.438,146.5 EBITDA 30,020.430,310.732,437.627,819.6 Net PP&E 79,791.386,193.388,000.691,088.3 Depreciation & amortization (10,673.1) (12,721.1) (13,550.0) (12,269.6) Net intangibles (114.5) 1,183.61,126.41,069.1 EBIT 19,347.317,589.518,887.715,550.0 Total investments 2,608.92,646.42,685.62,725.4 Interest income 64.252.558.268.8 Other long-term assets 12,640.15,947.15,915.8886.0 Interest expense (372.5) (1,262.6) (1,462.3) (1,065.9) Total assets 142,024.2129,333.2133,245.7133,915.2 Income/(loss) from uncons. subs.0.00.00.00.0 Others (728.3) (17.0) 581.680.3 Accounts payable 18,128.818,112.36,345.96,542.5 Pretax profits 18,310.816,362.418,065.314,633.2 Short-term debt 13,193.65,428.13,454.93,718.3 Income tax (5,776.6) (5,161.9) (5,699.1) (4,616.4) Other current liabilities 11,355.811,035.517,883.912,490.2 Minorities 0.00.00.00.0 Total current liabilities 42,678.234,575.927,684.722,751.1 Long-term debt 16,195.09,871.913,819.514,873.4 Net income pre-preferred dividends 12,665.511,317.812,495.710,121.8 Other long-term liabilities 4,224.2196.2186.4177.0 Preferred dividends 0.00.00.00.0 Total long-term liabilities 20,419.110,068.014,005.815,050.4 Net income (pre-exceptionals) 12,665.511,317.812,495.710,121.8 Total liabilities 63,097.344,644.041,690.637,801.5 Post-tax exceptionals 0.00.00.00.0 Net income 12,665.511,317.812,495.710,121.8 Common stock & premium 17,512.017,512.017,512.017,512.0 Other common equity 56,963.262,677.269,514.074,012.8 EPS (basic, pre-except) (Rmb) 0.720.650.710.58 Total common equity 74,475.280,189.287,026.091,524.8 EPS (basic, post-except) (Rmb) 0.720.650.710.58 Minority interest 4,451.74,500.04,529.14,588.9 EPS (diluted, post-except) (Rmb) 0.720.650.710.58 DPS (Rmb) 0.320.320.320.26 Total liabilities & equity 142,024.2129,333.2133,245.7133,915.2 Dividend payout ratio (%) 44.250.045.045.0 Free cash flow yield (%) 14.322.214.171.124 BVPS (Rmb) 4.254.584.975.23 Growth & margins (%) 12/0512/06E 12/07E 12/08ERatios 12/0512/06E 12/07E 12/08E Sales growth 115.9 (1.0) 5.80.3 ROE (%) 21.814.614.911.3 EBITDA growth 32.81.07.0 (14.2) ROA (%) 126.96.36.199.6 EBIT growth 38.5 (9.1) 7.4 (17.7) ROACE (%) 17.412.313.610.2 Net income growth 34.8 (10.6) 10.4 (19.0) Inventory days 57.765.839.044.4 EPS growth (3.7) (10.6) 10.4 (19.0) Receivables days 26.831.824.325.0 Gross margin 21.020.320.618.4 Payable days 188.8.131.521.7 EBITDA margin 23.724.224.520.9 Net debt/equity (%) 32.912.513.212.8 EBIT margin 15.314.014.311.7 Interest cover - EBIT (X) 62.814.513.515.6 Valuation 12/0512/06E 12/07E 12/08E Cash flow statement (Rmb mn) 12/0512/06E 12/07E 12/08E Net income pre-preferred dividends 12,665.511,317.812,495.710,121.8 P/E (analyst) (X) 184.108.40.206.2 D&A add-back 10,673.112,721.113,550.012,269.6 P/B (X) 1.00.90.80.8 Minorities interests add-back (131.3) (117.3) (129.6) (104.9) EV/EBITDA (X) 220.127.116.11.1 Net inc/(dec) working capital (1,604.9) 13,794.0 (6,500.5) (6,766.0) Dividend yield (%) 18.104.22.168.2 Other operating cash flow 1,027.6150.4160.9134.7 Cash flow from operations 22,630.037,866.019,576.515,655.2 Capital expenditures (9,833.6) (15,300.0) (15,300.0) (10,300.0) Acquisitions 0.00.00.00.0 Divestitures 0.00.00.00.0 Others (24,880.1) 1,501.2 (39.2) (39.8) Cash flow from investments (34,713.6) (13,798.8) (15,339.2) (10,339.8) Dividends paid (common & pref) (7,815.4) (5,603.8) (5,658.9) (5,623.1) Inc/(dec) in debt (621.8) (14,088.6) 1,974.41,317.3 Common stock issuance (repurchase) 25,410.70.00.00.0 Other financing cash flows (3,193.1) (3,979.7) 19.350.5 Cash flow from financing 13,780.5 (23,672.2) (3,665.2) (4,255.2) Total cash flow 1,696.9395.0572.11,060.1 Note: Last actual year may include reported and estimated data. Source: Company data, Goldman Sachs Research estimates. Analyst Contributors Song Shen firstname.lastname@example.org David Pow email@example.com August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 3 Exhibit 1: Baosteel 39% yoy earnings fall was driven by yoy price decline despite qoq improvement in gross margin Baosteel 1H 2006 results highlights Net profit (Rmb mn) 1H 052H 051H 06 Hoh % Yoy % % of 2006E Half-yearly 7,145 5,520 4,389 -21% -39% 39% 1Q 052Q 053Q 054Q 051Q 062Q 06 Qoq % Yoy % Quarterly 3,073 4,072 3,306 2,214 1,372 3,017 120% -26% Gross margin 20051Q 062Q 061H 06 HR 37.9% 13.2% 23.9% 19.1% CR 26.7% 15.1% 25.2% 20.9% Stainless steel -10.2% 1.2% 13.4% 8.1% Specialty steel 4.5% 3.9% 10.1% 7.3% Overall steel business 24.6% 12.6% 23.7% 18.4% HR price (Rmb/t, ex-VAT) 20051Q 062Q 061H 06 Baosteel average sales price 4,101 2,949 3,810 3,369 Baosteel contract price 4,384 2,991 3,642 3,317 Source: Company data, Goldman Sachs Research estimates. Exhibit 2: 2H06 sequential contract price improvement provides earnings visibility Baosteel 1H 2006 results highlights (Rmb/t, incl. VAT) 1Q 042Q 043Q 044Q 041Q 052Q 053Q 054Q 051Q 062Q 063Q 064Q 062H06 hoh growth % Baosteel quarterly prices HR 3,5504,6614,6614,6615,0125,4805,4804,5443,5004,2614,6124,37816% CR 4,7345,0855,0855,4365,9636,5486,5485,9634,4425,2615,6115,37713% Galvanized sheet 5,9866,1976,1976,1976,5487,0167,0166,7825,2615,4956,1396,78220% Silicon steel 5,9736,0906,0906,4417,1437,6117,6116,4415,2715,1545,4525,6286% Tin sheets 6,6607,2457,7728,2408,7089,1769,1769,1768,5208,5208,6958,9293% Color coated plates 5,8077,3797,3797,3797,6138,1988,1987,6136,6777,0877,555 N.A. N.A. Premium of Baosteel's quarterly prices over market prices HR -6% 2% 21% 2% 6% 7% 11% 16% 7% 10% 11% 11% CR -1% -8% -1% -4% -4% -7% -3% 4% -2% 2% 11% 11% Source: Company data, Mysteel, CRU, CISA. Flat product near term risk from volume ramp up cycle,2007 outlook better July production trend improving slightly The July flat steel production growth rate showed sequential decline after a 15% hot rolled price drop since the early June high. Hot rolled steels’ daily production grew by 36% yoy, compared to June’s 36% yoy growth, down 6.4% mom. The cold rolled steel daily production growth rate slowed to 45% yoy, compared to June’s 68% yoy growth, down 8.4% mom. Volume ramp up cycle still a near term risk, better supply outlook in 2007 Despite the sequential production rate slowdown, production volume is still at high levels, consistent with our belief that flat product is still going through the volume ramp up cycle. Flat product takes longer greenfield construction time, usually 2-3 years. Current strong volume growth is reflecting the strong investment growth since 2003, as shown in Exhibit 5. The government’s April 2004 macro tightening has sharply curbed the capex growth rate, utilizing administrative measures (cutting off loan and land supply). We see the capex growth rate as having been on a declining trend, to 1% in Jan-July period compared to 2005’s 28% and 2004’s 34% yoy growth. August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 4 We see better flat steel supply dynamics in 2007. The slowdown of HR’s volume growth rate compared to CR indicates we are close to the end of the volume ramp up cycle, in our opinion. CR is one of the last production stages of the flat steel production process. The rise in the CR production growth rate and decline in the HR rate indicate more CR capacity is being brought into production, absorbing the feedstock HR. Exhibit 3: HR production growth rate slowed down in July Hot-rolled steel production volume trend in China Exhibit 4: CR production growth rate still at high levels Cold-rolled steel production volume trend in China 216 206 251 311 320315 349349 373 387 407 381 271 311 309 46.0% 28.5% 35.8% 24.0%24.0% 16.2% 24.6%24.5% 22.0% 100 150 200 250 300 350 400 450 Ja n- 04 Fe b- 04 M ar -0 4 A pr -0 4 M ay -0 4 Ju n- 04 Ju l-0 4 A ug -0 4 S ep -0 4 O ct -0 4 N ov -0 4 D ec -0 4 Ja n- 05 Fe b- 05 M ar -0 5 A pr -0 5 M ay -0 5 Ju n- 05 Ju l-0 5 A ug -0 5 S ep -0 5 O ct -0 5 N ov -0 5 D ec -0 5 Ja n- 06 Fe b- 06 M ar -0 6 A pr -0 6 M ay -0 6 Ju n- 06 Ju l-0 6 ('000 t) 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% HR daily production (left scale) Yoy growth (right scale) 39 3635 37 43 4848 53 49 17 25 23 31 34 30 38 45.3% 67.5% 42.7% 60.6% 33.9% 46.4% 6.6% 18.3% 40.6% 28.2% 10 15 20 25 30 35 40 45 50 55 Ja n- 04 Fe b- 04 M ar -0 4 A pr -0 4 M ay -0 4 Ju n- 04 Ju l-0 4 A ug -0 4 S ep -0 4 O ct -0 4 N ov -0 4 D ec -0 4 Ja n- 05 Fe b- 05 M ar -0 5 A pr -0 5 M ay -0 5 Ju n- 05 Ju l-0 5 A ug -0 5 S ep -0 5 O ct -0 5 N ov -0 5 D ec -0 5 Ja n- 06 Fe b- 06 M ar -0 6 A pr -0 6 M ay -0 6 Ju n- 06 Ju l-0 6 ('000 t) 0% 10% 20% 30% 40% 50% 60% 70% 80% CR daily production (left scale) Yoy growth (right scale) Source: CEIC. Source: CEIC. Exhibit 5: Steel capex growth rate has been trending down since 2003 Capex in steel sector in China Exhibit 6: HR volume growth rate is slowing down yoy in 2006 relative to CR Yoy growth of daily production of HR and CR steel products 48 70 133 178 228 119 46% 89% 34% 28% 1% 0 50 100 150 200 250 200120022003200420052006 ytd (Rmb bn) 0% 20% 40% 60% 80% 100%FAI in steel (left scale) Yoy growth (right scale) 16.2% 46.0% 24.0% 35.8% 22.0% 28.2%33.9% 46.4% 6.6% 67.5% 45.3% 0% 10% 20% 30% 40% 50% 60% 70% 80% Fe b- 05 M ar -0 5 A pr -0 5 M ay -0 5 Ju n- 05 Ju l-0 5 A ug -0 5 S ep -0 5 O ct -0 5 N ov -0 5 D ec -0 5 Ja n- 06 Fe b- 06 M ar -0 6 A pr -0 6 M ay -0 6 Ju n- 06 Ju l-0 6 Yoy growth HR daily production CR daily production Source: CEIC. Source: CEIC. August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 5 RegAC I, Song Shen, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Investment profile The Goldman Sachs Investment Profile provides investment context for a security by comparing key attributes of that security to its peer group and market. The four key attributes depicted are: growth, returns, multiple and volatility. Growth, returns and multiple are indexed based on composites of several methodologies to determine the stocks percentile ranking within the region's coverage universe. The precise calculation of each metric may vary depending on the fiscal year, industry and region but the standard approach is as follows: Growth is a composite of next year's estimate over current year's estimate, e.g. EPS, EBITDA, Revenue. Return is a year one prospective aggregate of various return on capital measures, e.g. CROCI, ROACE, and ROE. Multiple is a composite of one-year forward valuation ratios, e.g. P/E, dividend yield, EV/FCF, EV/EBITDA, EV/DACF, Price/Book. Volatility is measured as trailing twelve-month volatility adjusted for dividends. Quantum Quantum is Goldman Sachs' proprietary database providing access to detailed financial statement histories, forecasts and ratios. It can be used for in-depth analysis of a single company, or to make comparisons between companies in different sectors and markets. Disclosures Coverage group(s) of stocks by primary analyst(s) Song Shen: Asia Commodities Companies. Asia Commodities Companies: Aluminum Corporation of China, Angang New Steel, Anhui Conch Cement, Banpu Public Company, Baoshan Iron & Steel, China National Building Material, China Shenhua Energy, Jiangxi Copper, Maanshan Iron & Steel, Wuhan Iron and Steel, Yanzhou Coal Mining. Company-specific regulatory disclosures The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, "Goldman Sachs") and companies covered by the Global Investment Research Division of Goldman Sachs and referred to in this research. Goldman Sachs expects to receive or intends to seek compensation for investment banking services in the next 3 months: Baoshan Iron & Steel (Rmb4.18) Goldman Sachs had an investment banking services client relationship during the past 12 months with: Baoshan Iron & Steel (Rmb4.18) Distribution of ratings/investment banking relationships Goldman Sachs Investment Research global coverage universe Rating Distribution Investment Banking Relationships Buy Hold Sell Buy Hold Sell Global 27% 59% 14% 57% 49% 45% As of July 1,2006, Goldman Sachs Global Investment Research had investment ratings on 2,129 equity securities. Prior to June 24,2006, Goldman Sachs utilized a relative rating system of Outperform, In-Line and Underperform, which, for the purposes of the above disclosure required by NASD/NYSE rules, equated to Buy, Hold and Sell. As of June 24,2006, Goldman Sachs assigns stocks as Buys and Sells on various regional Investment Lists; stocks not so assigned are deemed Neutral. Such assignments equate to Buy, Hold and Sell for the purposes of the above disclosure. See 'Ratings, Coverage groups and views and related definitions' below. August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 6 Price target and rating history chart(s) Regulatory disclosures Disclosures required by United States laws and regulations See company-specific regulatory disclosures above for any of the following disclosures required as to companies referred to in this report: manager or co-manager in a pending transaction; 1% or other ownership; compensation for certain services; types of client relationships; managed/co- managed public offerings in prior periods; directorships; market making and/or specialist role. 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ASONDJFMAMJJASONDJFMAMJJASONDJFMAMJ 2003200420052006 3 4 5 6 7 8 1,400 1,600 1,800 2,000 2,200 2,400 2,600 2,800 OP Oct 13 Baoshan Iron & Steel (600019.SS) Goldman Sachs rating and stock price target history Currency: Chinese Renminbi Source: Goldman Sachs Investment Research for ratings and price targets; Reuters for daily closing prices as of 07/01/06. Rating Price target Price target at removal Shanghai SEAShare Index; pricing by FactSet Covered by Song Shen, as of Oct 21,2005 Not covered by current analyst 5.50 5.20 5.506 S to ck P ric e In de x P ric e New equity ratings, were adopted on June 24, 2006 but are not yet reflected above. The new Buy, Neutral and Sell are equivalent to OP, IL and U. The price targets shown should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as well as developments relating to the company, its industry and financial markets. August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 7 Goldman Sachs Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. Coverage Suspended (CS). Goldman Sachs has suspended coverage of this company. Not Covered (NC). Goldman Sachs does not cover this company. Not Available or Not Applicable (NA). The information is not available for display or is not applicable. Not Meaningful (NM). The information is not meaningful and is therefore excluded. 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August 29,2006 Baoshan Iron & Steel (600019.SS) Goldman Sachs Global Investment Research 8 Copyright 2006 The Goldman Sachs Group, Inc. No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of The Goldman Sachs Group, Inc.