* H2 net 563.6 mln yuan versus forecast of 764 mln yuan
* 2010 net up 16 pct to record 1.37 bln yuan
* Geely sees challenges in 2011
* Analysts disappointed, sees tougher year ahead
* Shares tumble nearly 6 pct after results
By Alison Leung
HONG KONG, March 23 (Reuters) - China's Geely Automobile Holdings Ltd posted a surprising 4 percent drop in second-half earnings and said it could face significant challenges in 2011 from rising costs and subdued growth, sending its stock down as much as 6 percent.
China, the world's biggest auto market, has been a major bright spot for global automakers such as Ford Motor Co , Toyota Motor Corp and Hyundai Motor Co amid a global industry downturn, thanks in part to stimulus measures taken by Beijing in 2009.
But growth in Chinese car sales is expected to slow this year as tax incentives for small cars come to an end and Beijing takes measures to tackle traffic congestion in the capital.
"In the short to medium term, risks to our growth remain, in particular the high uncertainty of the global economy, rising raw material prices, higher inflation and thus tightening monetary policies in China," Geely, whose parent bought Ford's Volvo Car unit last year, said in a statement.
Geely posted a July-December net profit of 563.6 million yuan ($85.9 million), down from 587 million yuan a year earlier, according to Reuters calculations.
The result was below a consensus forecast of 764.4 million yuan from 19 analysts polled by Thomson Reuters I/B/E/S.
"Commodities, such as steel and metals, have seen prices rising and so the (entire auto industry's) cost efficiency will be affected," said Catherine Chan, a research analyst at BMI Funds Management.
Analysts said they were disappointed by Geely's results, hurt by a 56 percent rise in distribution and sale expenses that amounted to 1.19 billion yuan last year.
"I think they spent a lot of money on the advertisement of their new brand as they try to wash away the (old) Geely brand name. But it is going to be difficult because consumers are smart," said Jack Yeung, an auto analyst at BNP Paribas.
Geely, which means "lucky" in Chinese, has been seeking to shrug off its image as a producer of cheap cars. It has been phasing out the Geely brand and making new cars under different brands by employing more advanced technology.
SEES CHALLENGES
The Chinese car market is crowded with foreign players such
as Toyota and Volkswagen AG
A few industry observers, such as Rao Da, head of the semi-official China Passenger Car Association, have said car sales in China may fall more than 10 percent this year.
Geely shares fell about 6 percent on Wednesday after the results were announced, far underperformed by a 0.35 percent drop in the Hang Seng Index . Its stock has fallen 11.8 percent this year, versus a 1.1 percent drop in Hang Seng Index.
"I will maintain my sell recommendation on the stock. The reason is this year is going to be even tougher for low-end car producers because the government subsidies have gone already," Yeung said. "Domestic auto makers are reaching to a point where they have to cut the price and price wars have already started in the first quarter of this year."
Hangzhou-based Geely's February sales rose only 10.8 percent to 31,806 units, but better than rivals such as Warren Buffett-backed BYD Co Ltd , which reported a 22 percent drop in February sales. .
"Geely and others would still see some (volume) growth this year, but any growth should be limited as the overall market is slowing down," said John Zeng, an analyst with J.D. Power and Associates.
Geely has set a 2011 sales volume target at 480,000 units, up 15 percent from 2010.
For the whole of 2010, Geely reported its best-ever yearly net profit of 1.37 billion yuan, up 16 percent from 1.18 billion yuan in 2009.
Excluding non-cash expenses related to the recognition of share-based payments to employees, its underlying net profit rose 38 percent 1.64 billion yuan, the company said. ($=6.56 yuan) (Reporting by Alison Leung; additional reporting by Fang Yan and Chyenyee Lee; Editing by Charlie Zhu and Matthew Driskill)