Summary

Though with lower gold ore grade and adjusted business structure, Zhaojin Mining got lower earning capability, the higher gold price and increased sales volume still help its net profit increase 28.3% in 1H11. Through acquisitions outside Zhaoyuan and possible overseas M&A, its gold resources will keep rapid expansion and underpin its future growth. In comparison with international peers, Zhaojin Mining also enjoyes some characters of bull stock. In sum, we forecast its net profit will be RMB1.774 and 2.366 billion in 2011 and 2012, increasing 48% and 33% respectively, with EPS at RMB 0.61 and RMB 0.81.Giving the Company 30x P/E of FY11，its 12m TP will be HK$22.27, about 35% higher than the current close. We maintain it Buy rating.

Increased production and higher gold price underpinned largely grown performance in 1H1

According to the interim report, benefitting from higher gold price and increased sales volume, Zhaojin Mining realized the revenue and net profit of RMB2.5 billion and RMB0.72 billion in 1H11, respectively with 49.2% and 28.3% increase. Its gold production increased 12% y/y to 11.43 tons, among which the production of mine-produced gold reached 7.63 tons and that of smelted and processed gold was 3.80 tons. Meanwhile, because of the European sovereign debt crisis, its average gold price rose 19% y/y to RMB314.22/g in 1H11, even RMB8.09/g higher than the average gold price sold in the Shanghai Gold Exchange.

However, it is noteworthy that its gold ore grade declined to 2.6g/t in 1H11 though with largely increased gold price, then the integrated cost of self-produced gold added 14% to RMB116.97/g, among which that produced in Shandong and others was respectively RMB100.38/g and RMB163.44/g. Moreover, its smelted and processed gold business enlarged and the product structure was adjusted a little, with the smelted and processed gold business contributing from 21% in 1H10 to 25% in 1H11. Therefore, its earning capability was cut down, and gross profit margin decreased 8.86pps to 52.31%.

The resource reserve keeps increasing rapidly

Among four domestic largest listed gold manufacturers, Zhaojin Mining has won the most successful resource expansion through active acquisitions outside Zhaoyuan like Xinjiang. As at 31 December 2010, its gold ore resources reservation under the Code of The Joint Ore Reserves Committee in Australia (the “JORC”) were approximately 495.82 tons (15,941 kozs), and the minable gold reserves were approximately 251.89 tons (8,098 kozs).

By district, its 61.1% gold resources are located in Zhaoyuan in Shandong Province, and other 38.9% are in Xinjiang, Gansu and others. Reviewing its gold ore resources reservation and minable gold reserves, the CAGR since 2006 is respectively 31.8% and 20.65%. However, the CAGR of minable gold reserves in past three years is respectively 18.5% for Shandong Gold, 15% for Zhinbgjin Gold, and only 4% for Zijin Mining.

According to the plan, the Company may accelerate the pace of resource expansion and disperse the acquisition area. Besides the acquisition in mainland, it is also seeking overseas opportunities. Nowadays, it is preparing for two overseas M&A cases, which are in North America and Australia. In our view, because of limited domestic gold ore development space, acquisition abroad will support its stable development. Meanwhile, It is also adaptable to its decentralized development strategy. Zhaojin Mining forecasts that the average growth of gold production in Zhaoyuan district will be around 10% in coming five years, and that outside Zhaoyuan will be 30%. Therefore, the Company will avoid the risk of too focused regional development, and the gold production share outside Zhaoyuan will increase from present 16% to 50% around. What's more, its total mine-produced gold output will keep increasing stably, with the growth of 15% each year.

Lagging share price may be temporary

Though international gold price and gold ETF have surged around 30% since 2011, gold shares prices has lagged behind significantly. Even as the best performance, the ahare price of Zhaojin Mining has only increased about 10%. We attribute that to three reasons. Firstly, sluggish economic recovery and the sovereign debt crisis have dragged the performance of stock markets, and then suppressed the performance of gold stocks. Secondly, the development of gold ETF let investment in physical gold parts the investment in gold mining stocks. Thirdly, gold miners have faced higher labor and energy costs as well as increased capital expenditures.

However, through the investigation in international markets, it is not inevitable that gold stocks perform worse than gold price. Reviewing international gold miners since 2010, we find out two types of gold stocks lead the spot gold. The first includes the gold miners listed in A stock, among which Shandong Gold (600547.CH) performs best and has surged 35.6X since listed. The second is with the high-growth companies. Taking Goldcorp (G.CN) in North America as the example, its revenue and net profit has respectively increased 21X and 28.7X since 2001, which let its stock price surge 13.4X.

Zhaojin Mining also possesses some above characters. Firstly, it is with high growth since listed. Its profit growth since 2006 is close to that of Goldcorp but with stronger earning capability. Secondly, Zhaojin Mining plans to return to A stock. Furthermore, its businesses are focused in Shandong province nowadays. Therefore, the high valuation of A-stock may spur its H-share valuation.

Gold price on the upbeat

After about 20% hike in 1H11, gold price again had gone onto the acceleration path since July. Gold in London rose to $1920 per ounce on September 6 from $1500 per ounce on June 30. Thereafter, gold price has shuddered between $1800 and $1900.

In short term, we think gold price will maintain the pattern and present the possibility to take more time to win higher price. The previous rise over $400 had endured for seven weeks, and the increase has also been seen rarely in history. Therefore, gold price won`t record new high unless there are server crisises or unexpected easing quantitative monetary policies in near term. However, gold can`t experience deep callback because the gold market is going into the busy season.

In medium and long term, we belive the gold bull market will not change. First of all, international risk aversion sentiment can hardly be eased. Sovereign debt crisis has extended from the marginal countries in Europe to key countries such as France, Italy, Spain and the US and fiscal deficits also endanger most countries, but key economies seem to have no effective and material measures to solve the debt crisis. So, the crisis is likely to burst intermittently in medium and long term.

Secondly, international game is aggravating. This year the Pakistan-Israel conflict in the Middle East may break the pattern. Currently, more than 100 countries suport Palestein to join the United Nation, but the US and Israel still deny its founding. Therefore, the situation in the Middle East may aggravate the conflict. Furthermore, Iran nuclear crisis and other factors will also make the conflict worse.

Thirdly, the monetary value of noble metal may partly return. Currently, the US and some European countries have partly confirmed or are intending to confirm gold and silver coins as the legal tender, once again recovering the monetary position of noble metal. We believe restricted by supply, gold and silver find it hard to completely serve as global monetary media, but widely distributed notes have severely impacted the note creditability, the future international monetary system will not dismiss the possibility of restricting note distribution by introducing metal to reconstruct credit basis. Therefore, partial return of the monetary position of noble metal is not something distant. From this perspetive, the value of noble metal han`t been yet reflected.

Lastly, gloal economy is on the verge of degression with bad economic data in past two months.If the CPI in the US goes downward, we believe the US is expected to launch QE3, the rampant liquidity situation can hardly change, bracing up the gold price performance.

Risks

Global economy faces the second depression, which may drag the performance of capital markets;

The Company can`t increase the gold reserve as expected.

Continue buying gold stock

We think the gold will catch most investors` eyes in medium to long term, and the price will go up. After our estimation, we forecast the revenues for Zhaojin Mining will respectively reach up to RMB6.169 and 8.144 billion in 2011 and 2012, and the net profit will be RMB1.774 and 2.366 billion, increasing 48% and 33% respectively, with EPS at RMB 0.61 and 0.81.

Because of good profitability and growth for gold companies, we take P/E as the valuation method. Tracking international and HK's gold shares, the average historical P/E is normally 2 times that of the indexes. Since the 1990s, average P/E of HSI is around 14X. Based on the high growth and surging gold price, we think Zhaojin Mining should enjoy the premium, giving the Company 30x P/E of FY11. Then we give it 12m TP of HK$22.27, about 35% higher than the current close. We maintain it Buy rating.

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