China's largest beer maker, Hong Kong-listed Tsingtao Brewery Co Ltd, said recently it plans to crank up production of its more expensive, flagship Tsingtao beer to reduce the damage from rising barley prices.

"This will affect our earnings next year,?Chief Financial Officer Sun Yuguo said in an interview. "But the company will boost sales to improve margins.?

Some brewers in the world's second-largest beer market are expected to lower the barley content in their beers, switching to animal feed for lower-end brands, traders say.

Others, like Shenzhen-listed Yanjing Brewery, say they have stocked up enough barley to ride out the price rise.

Prices of imported malting barley ?which accounts for 15 per cent of Tsingtao's production costs ?have risen about 30 per cent in the past few months, Sun estimated.

Droughts in major producing countries have squeezed supplies.

Tsingtao will use 400,000 tonnes of barley this year, half of which will be imported from Canada, Australia and France, Sun said. Analysts said brewers would feel the pinch of higher barley costs next year unless they take steps to offset the impact.

"We estimate for every 1 per cent increase in malt prices, Tsingtao's 2003 earnings per share will be reduced by 1.5 per cent,?JPMorgan analyst Benjamin Lo said in a research note.

Lo, who has a neutral rating on Tsingtao, estimated imported malt prices have risen 37 per cent so far this year, while domestic malt prices have not changed significantly.

China's 20 billion-litre beer market, though highly fragmented with lots of producers, trails only the United States.

China's beer market is growing at 6 per cent a year ?as living standards rise with economic growth.

But tough competition and high barley prices are triggering a switch by China's 480 breweries from using malting barley to cheaper domestic grains ?including those normally used for animal feed.

Traders have said China's largest breweries are trying to keep the malt rate of their beers at 60-70 per cent.

But the low end of the market, which makes up about 80 per cent of China's output, was turning to feed grain.

Tsingtao, in which US beer giant Anheuser-Busch is raising its stake, produced 2.9 million tonnes of beer in the year's first 11 months, compared with 2.51 million tonnes in 2001, Sun said.

The company has targeted 2002 output at 3 million tonnes, including 800,000 tonnes of Tsingtao-brand beer.

A source at Beijing-based Yanjing said the impact of higher barley prices would be limited on Yanjing because the brewer had imported a substantial amount of barley earlier in the year.

"We have bought enough barley to meet our needs until August or September,?she said.

Sixty per cent of the barley used by Yanjing is imported. Yanjing plans to produce 2.5 million tonnes of beer next year, she added.

Shares in Tsingtao rose 2.58 per cent last Wednesday to close at HK$3.975 (51 US cents).

The stock had lost 1.3 per cent in the past month, but gained 9.2 per cent in the past three months to last Tuesday, and 65 per cent in the last year.

Beijing-backed investment bank Bank of China International (BOCI) late last month downgraded Tsingtao shares to "underperforming?and cut its forecast for Tsingtao's 2003 earnings per share by 9 per cent to 0.21 yuan (3 US cents).

(Business Weekly December 17, 2002)