Xinyuan continues to trade at a below average Price/Book ratio due to its below average profitability. If the company achieves operational improvements that raise net profit margins into a normal 10-15% range then the shares have 50-100% appreciation potential. Steps that Xinyuan could take to improve its profitability (from Benchmarking Xinyuan Real Estate after its rally):
- Prudent Land Acquisition Strategy
- Lower Financing Costs
- Maintain Strong brand Image
- Build Value Added Services
Recent news will be reviewed to see whether progress is made in these areas:
- Land Acquisitions. Prospects for land acquired by the company in 2016 look very good and Xinyuan has found success outside of standard public auctions.
- Bond refinancing. The company has reduced its interest burden through a variety of financing channels
- 3Q Financial Results & 4Q Guidance. A weaker market following imposition of home price restrictions may depress results for the next few quarters, but the company is well positioned to take advantage of the downturn by acquiring new land.
- Listing of Property Management Business. Successful completion of a domestic listing could bring attention to the $40-$86mm value of this subsidiary and enhance its growth potential
Valuation comps as of 11/18/16:
Land Acquisitions
Xinyuan’s challenge is to acquire land for development at reasonable prices in good markets. As described in China Property: Hot or Not?, home price strength is limited to a few regions which contain nearly all of the cities that recently imposed housing market restrictions. These areas have strong local economies with rising wages and growing populations that create genuine demand for new and better quality homes.
A look at Xinyuan’s latest purchases and recent news about some older acquisitions:
- Zhengzhou (10/26/16 press release) land acquired at a floor price of 2,033 RMB/sqm. This parcel is immediately adjacent to Xinyuan’s “International New City”鑫苑国际新城 project which began presales in September 2016 after the land was acquired in April (4/22/16 press release) at a floor price of 1872 RMB/sqm. While Xinyuan paid a little bit higher price than in April home prices in the surrounding district have risen sharply and the project should earn an excellent gross margin (assuming development and marketing costs of 4000-6000 RMB/sqm)
The International New City project site falls under Xinyuan’s cooperation agreement with the Zhengzhou government. The company worked with the government on planning for the site and advanced funds for land preparation. These deposits are credited with interest against the acquisition price when related land comes up for public auction. In a sense the cooperation agreement can function like a virtual landbank providing access to land when the company is ready to use it without the financial burden of buying the land years in advance. However this year’s strong housing market led some to worry that even with the benefit of a discount Xinyuan could be outbid when these parcels are posted for auction. Obviously that did not happen at Zhengzhou International New City and Xinyuan was able to expand the project at a very attractive land price. Early success of the first phase means the second phase land purchase is a low risk investment.
- Changsha (10/26/16 press release) land acquired at a floor price of 3163 RMB/sqm. Changsha has not been one of the country’s top markets (average home price +4.5% in two years ended 9/30/16), but it was one of the strongest in October because it does not yet have the same restrictive housing policies recently imposed in most other central Chinese provincial capitals (e.g. Zhengzhou, Jinan, Hefei, Chengdu). Xinyuan’s new plot is about 500m from a recent “Land King” transaction in which a developer paid a much higher price of 6115 RMB/sqm. New homes in this area are currently selling for 7000-8000 RMB/sqm.
As of 6/30 Xinyuan was estimating a 27% gross margin from its Changsha Xinyuan Splendid project. 70% of the GFA had been sold as of 9/30 but the company had only achieved 45% of projected revenues. The remaining space includes three types of units that will sell at much higher ASP: premium apartments, commercial space, and parking. If successful then it would bode well for the prospects of the new land purchase if the project design incorporates some premium space as at Changsha Xinyuan Splendid.
- Queens, New York (8/1/16 press release) land acquired at a floor price of US$175/sf. The Flushing neighborhood has become New York’s real Chinatown so the location is a natural fit for a Chinese developer and apartments should have significant appeal to mainland Chinese buyers. The landmark designation of the old theatre at the site was a deterrent to some developers, but gives Xinyuan an opportunity to incorporate historic features in a way that add value at this site and also intangible benefit to the company’s brand image in China. A photo of the unrestored lobby:
Source: Afterthefinalcurtain.net (more at Keith-Albee Theatre, or RKO Keith’s Theater)
- Hell’s Kitchen, New York (1/14/16 press release) land was acquired at a floor price of about $550/sf. The high price relied on the potential return from the 20% of the space allocated for retail use. Local media recently reported that XIN cooked up a great deal with Target signing a 20 year lease for 80% of the space. Having this anchor tenant reduces the risk from this development in a weakening Manhattan condo market and should facilitate project financing on favorable terms.
During the 3Q conference call Xinyuan disclosed that it has prepared 2Bn RMB for land acquisitions in 4Q16 with an additional 3-4Bn RMB in 1Q17. The company’s profitability suffered in the past two years from high prices paid for land at the 2H13-1H14 peak of the last cycle (see Comments on Xinyuan Real Estate’s Gross Margins). Xinyuan’s unrestricted cash on hand of $928mm at 9/30 puts the company in a good position to take advantage of opportunities that may arise over the next six months amid weaker industry sales and tighter access to financing. Savvy land acquisitions would build a foundation for much better returns in the next upturn (which the company expects in 2H17).
Xinyuan has a good record over the past year with land bought outside of traditional public auctions through arrangements that can require months or even years of negotiation and planning. Beijing Liyuan and Kunshan Xindo were privately purchased and both will enjoy excellent margins. Zhengzhou International New City was purchased through the long-term cooperation agreement and is likely to also provide an excellent margin with below average risk. It’s possible that purchases announced over the next six months will represent the culmination of similar efforts.
Refinancing
Xinyuan refinanced its 13.25% US$ 2018 bonds with proceeds of a new 8.125% US$ 2019 bond. The savings from the lower interest will enhance annual EPS by $0.11 (assuming a 25% tax rate).
The bond refinancing is one of many steps the company took over the past year to broaden its sources of funding and reduce borrowing costs. At 6/30/15 Xinyuan had $996mm of RMB debt with a weighted average interest rate of 10.25% reflecting heavy reliance on non-bank financing. At 6/30/16 the company had $1181mm of RMB debt with a weighted average interest rate of 8.61%. The reduction was achieved through increased access to bank loans plus issuance of domestic corporate bonds. Further savings are likely over the next nine months as most of the company’s high cost non-bank debt matures.
Most of the company’s borrowed funds are devoted to projects under development so the related interest expense is capitalized. The benefit of lower rates will be realized through lower “cost of real estate sales” leading to higher profit margins.
3Q Financial Results and 4Q Guidance
Third quarter results were strong as should have been expected amid buoyant sentiment in some of the company’s markets (see Xinyuan 3Q16 Contract Sales Estimate from CRIC).
Investors may have been disappointed that Xinyuan did not repurchase any shares in the quarter. CFO Helen Zhang mentioned in the 3Q conference call that the buyback operates with a price ceiling. Observation of trading activity in 2Q led me to believe the ceiling was probably $5 because there seemed to be steady demand under that level, but not above. Lack of any repurchase in 3Q when the price surged past $5 also suggests the ceiling was around there. A price of $5 appears very cheap based on P/B and P/E, but the share price was under that level for most of the period from 2010-2016 so if $5 was the ceiling then it would have been a reasonable decision by management. Helen Zhang said: “probably we’re going to start repurchase sometime in Q4 depending on the change of the stock price“. Some parameters of the share buyback were described in Xinyuan Real Estate’s Aggressive Share Repurchases Send a Strong Signal About Shareholder Value. The bond indentures set an annual cap of $50mm on dividends plus buybacks and I estimate that the company has used $41.6mm ($21.2mm buyback + $20.4mm dividends) leaving $8.4mm for potential repurchases. Prior repurchases demonstrated the company recognizes the benefit from accretive buybacks so I would not be surprised if the ceiling price were raised, perhaps to $6.
Despite the adverse translation impact from a weakening RMB, Xinyuan’s book value per share increased from $13.11 at 12/31/15 to $14.08 at 9/30/16 and shareholders received an additional $0.20/share in dividends during that period.
Xinyuan reduced full year guidance for contract sales to 9.6-9.9Bn RMB and net income to $75-78mm. It’s unclear whether guidance includes or excludes the one-time pretax cost of $10mm for early bond redemption. The primary reason for the reduction in guidance is the deferral of development of the Beijing Liyuan project to 2018 (for background see Xinyuan Real Estate’s Beijing Liyuan Project). Helen Zhang mentioned that the company expects to recognize revenue of $340mm from the Oosten project in the coming quarter. It’s unclear whether this was included in the company’s 2016 sales and income guidance.
The reduction in 4Q guidance may have been a significant factor in the 15% fall in Xinyuan’s share price on the day after the earnings release. It would be helpful if future company guidance more clearly explained the sales and income forecasts (actual numbers in RMB and USD rather than just percentage changes) and details of any significant items included or excluded.
Listing of Property Management Business
Xinyuan filed an application to list its property management business on China’s New Third Board, a domestic OTC market. The company cannot comment on the listing while the documents are under review and there is no guarantee that it will proceed. Several comparable businesses are traded in Hong Kong:
An independent listing would draw attention to the value of this steadily growing asset-light business. Xinyuan currently manages less area than the industry leaders but ranked an impressive 14th nationally in a comprehensive CRIC assessment combining measures of scale, service quality, growth potential and social responsibility.
A successful listing would be fairly valued in a range of US$40-$86mm. It could provide currency for accretive acquisitions of management contracts from other developers (as Colour Life has done). It could also set a precedent for future domestic listings of other subsidiaries, perhaps even Xinyuan China 鑫苑中国 (the primary real estate development business).
Conclusions
Lower 4Q16 guidance may have drawn attention away from a wide range of positive company developments in recent months.
The company has returned $41mm this year to shareholders through dividends and buybacks. I believe the company will resume share repurchases in 4Q16 using some or all of the remaining $8mm capacity.
The company has prepared abundant liquidity to cope with a temporary slowdown in the Chinese property market and opportunistically add to its landbank.
Smart land acquisitions would substantially expand Xinyuan’s future profit margins and would be a catalyst for a 50-100% re-rating of the share price.
Domestic listing of the property management business would be a savvy corporate decision that would bring attention to the value of this unit and enhance its future growth potential.
Koneko Research 