ANALYSTS generally praise Dongfang Electrical Machinery's leading position in the growing electricity industry in China but are concerned that its profit margin could be eroded by an increase in raw material costs. ''From an industry point of view, the company is in a promising China market of manufacturing electric generators, with minimal competition,'' said Desmond Cheung, an analyst at PBI Securities. Dongfang, the next mainland state-owned enterprise to float in Hong Kong with H shares, is one of the two largest manufacturers of hydro turbine generators in China - the other being the Harbin Power Plant Equipment Group in Heilongjiang province. It is also one of the three key makers of thermal generators in China under the Ministry of Machinery Industry. Located in Sichuan province, Dongfang has a geographical advantage over domestic and overseas competitors because of its proximity to the hydro resources along the Yangtze River, including the massive Three Gorges dam. Lawrence Lo, an analyst at Smith New Court, said an annual business growth of 20 per cent would be possible for Dongfang, given the thirst for electricity in China as it made big strides in economic development. While there appears no downside on the demand front, analysts said the company's biggest potential risk would be pricing. ''The question is whether the company can shift its increase in cost to its buyers, along with a price deregulation in China,'' said Mr Lo, pointing out that raw materials, mainly steel, accounted for 70 per cent of its cost. Dongfang chairman Yuan Changhe said earlier the company was able to transfer the rise in costs to its customers under orders agreements. He said a price adjustment was made when there was a substantial change of government policy. The company also had the right to revise upwards the price in accordance with the country's major gauge of inflation, he added. Dongfang posted a turnover of 356.6 million yuan (about HK$315.6 million) last year, with 57 per cent coming from the manufacture of hydro turbine generators. About 30 per cent was provided by the production of steam turbine generators and 7.7 per cent by electric motors. But the gross profit margin of hydro turbine generators was comparatively lower than that of steam turbine generators which posted margins of up to 50 per cent for a standard 300 megawatt unit in the past three years. Mr Yuan expected a margin of 60 per cent this year for steam turbine generators as a result of an increase in selling price. ''The percentage rise in price has been growing faster than the manufacturing cost,'' he said. The company's overall gross profit margin was about 35 to 40 per cent after deducting direct manufacturing cost from turnover, with the net profit margin at 15 to 20 per cent, he said. He attributed the more generous profit margin on steam turbine generators to short pay-back period. The development costs could be recouped fast as they were standardised products. A 300 MW steam turbine generator, sold for 12 million yuan in 1991, now would fetch 20 million yuan, said Mr Yuan. Mr Cheung was worried that Dongfang's profit growth would be restricted due to its limited scope to switch into more lucrative thermal generators under administrative direction from the central Government. He said the company's technological gap compared with overseas competitors was counterbalanced by a lower product price. But he expected it to lose the advantage as China rejoined the General Agreement on Tariffs and Trade. The company's planned alliance with Siemens of Germany, Hitachi of Japan and General Electric of the United States would help improve its technological knowhow, he said. Dongfang intends to boost its exports to 30 per cent of its turnover by 2000. It sold 10 per cent of its products to overseas countries last year, making a foreign exchange income of US$6 million. Mr Yuan expected the company to earn about US$10 million in foreign currency by exporting 15 per cent of product overseas.