China is believed to have experienced its first gold rush during the Tang Dynasty in the 9th century. It even led one of the era’s most famous poets and social commentators, Bai Juyi, to express his horror at the huge numbers of peasants leaving their ancestral lands to try and make their fortune along the river banks. Gold cannot be eaten or worn he wrote. It will not feed a man who is hungry and cold.
Some 11 centuries later and China’s appetite for gold remains undimmed, as does its inability to satisfy that demand from its own mines. The country is now the world’s largest consumer, but domestic production can only fulfill about 30% of its needs. The ratio will progressively decline given China holds just 3.5% of global gold reserves but accounts for more than 20% of global consumption.
To rectify this, leading producers have been following the country’s state-owned enterprises along the well-worn trail of the global M&A circuit. Leading the charge is China’s largest gold producer, Zijin Mining, which is listed both in Shanghai and Hong Kong.
The company has been working hard to improve its image since 2010 when it was better known as one of the country’s worst polluters after 9,100 cubic metres of acidic copper found its way into a local river, killing four million fish. It took Zijin nine days to even admit there was a problem.
Eyebrows were also raised when it created China’s largest open pit mine in 1997 by using 1,000 tonnes of explosives to blow the top off Zijinshan, a mountain near Shanghang county in Fujian province. As we reported in WiC15, Zijin has made many of the inhabitants of Shanghang extremely wealthy (they got shares). Not least among these is chairman Chen Jinghe who started life as a state geologist before forming Zijin with the help of the local government. Today, the Shanghang government still remains the largest single shareholder with a stake of 26.3%.
These days Zijin is very keen to burnish its environmental credentials. On its website the company says: “Gold and silver we explore, mountain and clear water we care even more.” The company’s motto may not have the lyricism of a Tang Dynasty poem, but its message is very clear.
Similarly Chen Jinghe was very explicit about the company’s strategy in a recent interview with China Economic Weekly. “No acquisitions, no future,” he said of the domestic gold mining industry.
The magazine estimates that Zijin spent about $1 billion in acquisitions during 2014. In the process, the miner has rapidly propelled itself up the global league tables. It still has nowhere near the same kind of international profile as longer-established rivals, although its current market capitalisation, at around $10.5 billion, has already leapfrogged the New York-listed Barrick Gold on $7.4 billion. Zijin is now not that far behind the world’s largest listed pure play, Goldcorp on $11 billion.
All the world’s listed gold companies have suffered a spectacular fall from grace since the metal started its decline from its all time high of $1,921.50 per ounce in July 2011. Both Barrick Gold and Goldcorp have lost almost 90% of their stock market value over the past four years.
Zijin’s big fall has been more recent. Earlier this year, its stock was one of the biggest beneficiaries of China’s A-share frenzy. Since June, it has been one of the biggest losers as retail investors dump basic materials stocks, with Zijin almost halving in price.
More significantly, Zijin is now the world’s biggest gold company in terms of revenues. For the first half of this year, it posted revenues of Rmb38.8 billion ($6.1 billion), above Goldcorp’s $2.2 billion and Barrick Gold’s $4.5 billion.
It is still not yet as profitable as Goldcorp, which reported net income of $305 million to Zijin’s $204 million. This is largely because Goldcorp has one of the best unit cash costs in the industry (roughly $547 per ounce), whereas Zijin still remains towards the other end of the scale, at around the $730 level.
But Zijin has already outstripped Barrick Gold, which reported a first half net income of just $80 million thanks to a heavy $10.7 billion debt load. Barrick Gold aims to reduce debt by $3 billion this year and has been offloading assets including a 50% stake in its Porgera gold mine in Papua New Guinea, which Zijin snapped up for $298 million.
Analysts believe the deal was fairly priced – at an enterprise value-to-reserve of about $45 per tonne. This is very low compared to the $150 to $250 industry average, but reflects the difficult operating environment of the mine, which is located on remote, rugged mountainous terrain.
Some question just how lucrative Zijin’s expanding asset pile will prove to be. Two of its other recent acquisitions, for example, are in the Congo. They include a 49.5% stake in Ivanhoe’s Kamoa mine and a 51% stake in the nearby Kolwezi copper mine. To address power supplier issues, the company is already planning to fund repairs at three local power stations.
Zijin’s first major international acquisition was Australia’s Norton Gold Fields in 2012 when it paid $223 million for an 87% stake. This acquisition has also prompted its most recent sally – an A$0.10 per share bid for a neighbouring Western Australian company called Phoenix Gold.
Late last week, Phoenix Gold’s board recommended investors reject the offer, which is below an independent valuation of A$0.156 to A$0.244 per share. It is also below a competing cash and shares offer from existing shareholder Evolution Mining, which was initially valued at A$0.12 in mid-May and is now worth A$0.13 according to analysts.
Chairmen Chen confused the situation last week when he appeared to suggest that Zijin would not be increasing its offer as many had expected.
But analysts say that Zijin’s ongoing M&A strategy is likely to be its main share price driver over the next few years and that it makes sense for the company to take advantage of cheap domestic capital to purchase international assets while prices are low. (Zijin has plans to raise Rmb10 billion via a new issue of A-shares, but is somewhat hostage right now to volatile market conditions in Shanghai and regulatory approvals.)
Yet a key factor will be whether the gold price continues to fall – many predict it will drop further if the US dollar gets stronger. At its nadir in 1999, gold sank to just $251.70 per ounce. It is currently trading around the $1,119 level.
One bank forecasts that 32% of the world’s gold miners will become free cashflow negative below $1,000 per ounce. During the second quarter Goldcorp cut its dividend by 60% so it could remain free cashflow positive.
Zijin must also hope its growing international profile does not provoke the same response the first Chinese miners received when they sailed across the Pacific during the US gold rush. It is estimated that the number of Chinese immigrants in California rose by about 3,000% between 1849 and 1876.
And as the gold rush failed to deliver the promised riches, anti-immigrant legislation soon followed. It included the infamous Anti-Coolie Act, the Pigtail Ordinance (relating to the distinctive queues the Chinese miners wore their hair in) and culminated in the Chinese Exclusion Act of 1882, which banned Chinese immigration to the US altogether. It was not repealed until 1943.
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