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An unremarkable golden industrial concept stock has surged 11 times in three years.

Since the beginning of this year, as the Federal Reserve's rate hike cycle approaches its end and the global de-dollarization process accelerates, the international gold price has risen from 1800 yuan to 2048 yuan, nearing its historical high. Despite the rate hike cycle not yet finished, the market generally expects the international gold price to hit a new high this year.

With the rise in international gold prices, many golden industrial concept stocks have performed well. Interestingly, we found a state-owned enterprise reform golden industrial concept stock in the Hong Kong stock market - Chinagoldintl (referred to as CICC International). In just three years, it has surged an astonishing 11 times, and its valuation is lower than A-share gold stocks.

So, how did a state-owned enterprise stock achieve such a magnificent 11-fold surge?

What is the unique strategy of state-owned enterprise reform in the gold industry?

First, as mentioned before, the current macro environment provides unique historical opportunities for the gold industry. With changes in monetary policy and the macro environment, the profit side of gold enterprises will be boosted.

For example, China's promotion of de-dollarization, global central banks purchasing large amounts of gold, China facilitating reconciliation among the most powerful factions in the Middle East, oil-producing countries balancing production cuts with the US, these are unprecedented macro phenomena since the dissolution of the Bretton Woods system, indicating a decline in US influence.

The current transitional period has similarities with the Bretton Woods system, geopolitical tensions are escalating, and countries are increasingly trying to break free from the US dollar dominance. Global central banks accumulating gold to reduce USD reserves signifies the US's century-long effort to dispel the allure of gold in human minds, but now facing the backlash of US Fed's monetary policy abuse, the bell for Bretton Woods 3.0 version has already tolled.

With the macro trend stable, the value of golden industrial concept becomes prominent. So, under the confirmed major trend, how to choose golden industrial concepts with more certainty or more stability?

CICC International has seen a tenfold increase in the past three years, which has a significant correlation with its parent company, China Gold International.

It is well-known that state-owned enterprises are usually considered representatives of stable development, with lower elasticity compared to other private enterprises. However, state-owned enterprise gold industrial concept possesses characteristics that other gold industrial concepts do not have. This characteristic is also the most direct way for gold enterprises to achieve high growth.

When resource stocks develop to a certain extent, they need to expand resource quality through mergers and acquisitions to change their profit capabilities. In other words, mergers and acquisitions are the most direct factor for resource stocks to achieve high growth. However, acquiring high-quality assets naturally requires paying a premium, which may be beneficial for the company in the medium to long term.

Acquisitions in the countercyclical period may bring greater pressure in the short term. However, if the parent company injects mining assets into the company, it is equivalent to the enterprise enhancing its profitability factor without paying the acquisition fee.

Currently, both CICC International and Zhongjin Gold benefit from this logic. With the active promotion of state-owned enterprise reform in the past two years, the parent company China Gold Group has injected high-quality mineral resources into CICC International and Zhongjin Gold, replacing poorly performing mines within the companies to enhance their profitability factor.

CICC International will inject four high-quality overseas gold mines owned by the parent company, increasing CICC International's mineral reserves by nearly 10 tons after the injection, with an estimated production of 7.5 tons of gold in 2023.

However, copper revenue accounts for 70% of CICC International's revenue. The market expects that after the injection, gold revenue will exceed copper revenue, which is a key point. This is because during an economic downturn, gold prices may rise, but when the proportion of copper revenue in the company is too high, copper performs poorly during an economic downturn, directly impacting the company's profits.

So the market has been astonishingly strong in recent times due to the expectation of a major shareholder injection and a sharp rise in gold prices. Zhongjin International's A shares have also doubled in the past year, benefiting from the expectation of asset injections from the parent company and the recent rise in gold prices.

Of course, it has always been an expectation before the injection of resources. Another advantage of Zhongjin International is the stability of the central enterprise management and the undervaluation of Hong Kong's gold stocks.

Looking back at the development history of Zhongjin International over the past few years, it is a story of the transformation of an undervalued central enterprise stock. As shown in the chart below, from November 2016 to June 2020, Zhongjin International once dropped by nearly 80%.

Second, the story of the doubling of typical undervalued central enterprise stocks.

As most of Zhongjin International's revenue comes from the price of copper, the upward trend in copper prices over the past few years has significantly improved Zhongjin International's profit margins.

In 2016, the price of copper was $4,500 per ton. Also, the softening of the RMB exchange rate that year resulted in significant losses for Zhongjin International in terms of exchange rates, with a net loss of 92 million for the whole year.

However, in 2017, the RMB exchange rate strengthened, and the price of copper surged to above 7000 yuan. In the third quarter of 2017, Zhongjin International's copper mine Phase II expansion has reached production, adding a daily capacity of 22,000 tons. In line with the rise in copper prices, that year Zhongjin International achieved its highest profit since going public, with a net income of 0.413 billion yuan for the whole year.

However, at the beginning of 2018, due to the Fed's interest rate hikes, global growth slowdown, and the impact of the US-China trade war. The prices of gold and copper began to decline, and the exchange rate weakened for two years, again dragging down the profits of gold enterprises. In 2018, Zhongjin International suffered a loss of 33 million yuan, and in 2019, a loss of 0.229 billion yuan.

However, since 2020, Zhongjin International has started a surge in the share prices of golden industrial concepts.

This is mainly due to gold hitting a record high of $1970 in 2020, and copper benefiting from the interest rate cuts by the Fed, leading to an uptrend. In 2020, Zhongjin International's net income reached a historical high of 0.731 billion yuan.

The Fed's interest rate cuts supported the rise in copper prices until 2021, with copper prices rising by 22% in 2021, but gold prices fell by 4%. However, for Zhongjin International, which has a large proportion of revenue from copper, this was a significant improvement in profitability.

So in 2021, Zhongjin International's net income increased year-on-year from 0.731 billion yuan to 1.7 billion yuan. The significant increase in net income for two consecutive years caused the company's stock price to rise from 3.2 yuan in June 2020 to 29 yuan at the end of 2021, an increase of up to 5 times.

After entering 2022, the price of copper has dropped by nearly 5% compared to 2021, while the price of gold first fell and then rose, with an almost flat full-year decline. Due to geopolitical factors last year, the medium and long-term logic of gold was supported by central banks of various countries, leading to a rebound in golden industrial concept in the fourth quarter after consecutive declines in 2 quarters. It is expected that the rate hike cycle of the Federal Reserve has peaked, and chinagoldintl saw a full-year increase of 9% last year.

However, the current rate hike cycle of the Federal Reserve has not yet ended. But the upward trend of the US dollar continues to limit the space for gold. In addition to expectations of performance and asset injections from the parent company, another point is that, as mentioned above, the PE of chinagoldintl is significantly lower than the valuation of the golden industrial concept in the A-share market.

In a horizontal comparison (denominated in RMB), chinagoldintl had a revenue of 7.7 billion yuan, net income of 1.551 billion yuan, and a market cap of 13.5 billion yuan in 2022. However, Yintai Gold Co.,Ltd. in the A-share market had a revenue of 8.4 billion yuan, net income of 1.244 billion yuan, and a market cap of 32.9 billion yuan in 2022.

Of course, there is a liquidity gap between Hong Kong stock and A-share market. Better liquidity will definitely bring a higher premium. However, chinagoldintl currently only has a PE ratio of 8, comparison with A-share market where gold enterprises have a PE ratio of 30, it is certainly much cheaper. But there are also reasons why the valuation of Hong Kong stocks is more rational.

It is worth noting that the biggest risk when investing in golden industrial concept in A-shares or Hong Kong stocks is not about how the company's mining assets perform, but rather concerns about the management's operations in terms of equity that may cause a short-term substantial drop in stock price. Therefore, when selecting golden industrial concept for investment, investors should consider the changes in the company's shareholding situation.

For example, Yintai Gold announced in December last year that its largest shareholder, Shen Guojun, transferred 20% of Yintai Gold's shares to SD Gold at a premium rate of up to 92%. Although almost doubling the sale price, Yintai Gold's stock price once dropped by 30% after the transfer.

Looking from a medium to long-term perspective, SD Gold's high premium acquisition certainly shows confidence in the future prospects, but it also hurts investors who entered at high levels.

Of course, most shareholders naturally cash out and leave after a sharp rise in stock price, but central enterprise management tends to reduce their shareholdings less frequently. This helps to avoid the extent of harm to investors caused by major shareholders selling off.

Conclusion

CICC's trend over the past few years is a typical undervalued cyclical resource stock. Despite the decent increase in value this year, there is still an 8% dividend yield.

When choosing high-quality gold companies, one should select companies with a higher proportion of gold. Currently, China International Capital Corporation (CICC) still generates nearly 70% of its revenue from copper. Market expectations are that the parent company will inject gold mine assets to address the issue of overly high copper composition. From a valuation perspective, CICC's market cap is also lower than its peers. However, in the current situation where copper prices are under pressure this year, if there is an economic recession, gold companies with excessive copper exposure may see a decline in profits.

Indeed, the US interest rate hike is still ongoing, and there may even be further rate hikes after the one in May, indicating that the suppression on gold prices is not over. However, the de-dollarization trend has already begun. In the global de-dollarization process, geopolitical tensions may increase, benefiting gold in the midst of this turbulent world.

$CHINAGOLDINTL (02099.HK)$

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