Key information from Xinyuan results and recent developments
- Xinyuan 1Q17 sales were above guidance and the company hinted that it expects a 42% increase in contract sales for the full year.
- Net Value delivered for shareholders in 1Q17 through book value increase + dividend of $0.38/share
- Strong financial condition and prudent approach to land acquisitions leave the company well positioned to withstand unexpected market weakness
- Institutional selling has been driven by Quant funds rather than investors who have conducted any company specific research.
Xinyuan’s first quarter results and conference call support the key points from my prior article (Xinyuan Real Estate: Improving Profitability Not Reflected in Falling Share Price). Improving profitability removes justification for a lower valuation than Hong Kong listed peers which trade at substantially higher levels. Xinyuan would be fairly valued at a price around $9.08 (65% of book value of $13.97).
Contract Sales were 9% ahead of one year ago (compared to guidance of “about the same”). During the conference call CFO Helen Zhang provided an outlook for 2Q17 sales 20% higher than a year ago and for 65% of full year sales to be recorded in the second half. This implies:
I contacted Xinyuan to confirm whether this was indeed their outlook and I was told that my calculation was “logical”, but the company is unwilling to commit to full year guidance at this time due to the uncertain outlook for government policies. Investors can review the conference call transcript and draw their own logical conclusion:
Share Repurchase was aggressive in 1Q17 with $7.181mm spent to acquire 1,367,400 shares ($5.25/share). The company’s new bond indentures cap dividends and share repurchase at $50mm/year when the Fixed Charge Coverage Ratio is below 2.5 (the June 2019 bond has a $35mm cap, but it should be called soon). Dividends of $0.10/quarter will be about $25mm for the year leaving about $25mm for buyback. Buying aggressively early in the year makes sense if the company expects that very strong second half results could push the share price higher. It’s possible that strong second half earnings combined with lower financing costs could put the company over the Fixed Charge Coverage Ratio and past the limit on use of funds for buybacks.
Land Acquisitions budget for the year is about US$1Bn (RMB 6.8Bn). Xinyuan appears to be taking a conservative approach with a land budget of 6.8Bn well below expected contract sales. About 1.3Bn has been spent so far including RMB 697mm RMB in January for Zhengzhou land acquisition and RMB 236mm in January for a Changsha land acquisition. The balance of about RMB 367mm was an equity contribution to a joint venture with one or more other developers for a joint bid on a land acquisition. These combinations have become a popular way for developers to limit risk from high-priced land purchases and also reduce bidding competition at land auctions. The joint venture in which Xinyuan invested has not yet acquired any land. Competition in land acquisition in attractive markets remains intense even as governments try to restrict the prices at which apartments can be sold.
Gross Margin improved to 22% in 1Q17 compared to 21% a year ago. Margin should rise in coming quarters as low return projects are sold out and the projections required for percentage of completion accounting show that active projects at 12/31/16 will earn an average margin of 30%.
Note that 20% of 1Q17 sales were from the Oosten project in Brooklyn which is earning a below average margin (additional comments below).
Operating Expense was relatively high at 12.6% of revenues. More efficient peers are under 10% so Xinyuan has scope for improvement. Expected higher sales volume over the remainder of 2017 should spread fixed costs over a larger revenue base and lower the company’s operating expense ratio.
Investment Properties held for leasing had an occupancy rate of 95% at 3/31/17. The 20-F included this breakdown of value attributed to different property types:
Most of the value is in two shopping malls:
- Xinyuan Priority Lifestyle Shopping Center covers 47,109 sqm at the Zhengzhou Modern City project and opened in 2013
- Xi’an Xinyuan Metropolitan Shopping Center covers 115,374 sqm at the Xi’an Metropolitan Project and opened in December 2016.
A 95% occupancy rate is an excellent performance for the newly opened Xi’an mall and bodes well for the valuation of this asset. Development of future residential phases at Xi’an Metropolitan should further enhance the performance of the commercial space. 1Q17 results did not break out rental revenue so there is not yet enough information to estimate possible appreciation in the fair value of these property assets.
Institutional Sales of Xinyuan stock appear to have pushed the share price lower during March. Notably, the none of the largest sellers invests based on fundamental stock analysis:
Something in the YE16 financial results appears to have triggered selling by quantitative investing models, but these firms do not conduct any company specific research. Bank and brokers hold trading positions for a variety of reasons mostly unrelated to an assessment of company outlook. Unfortunately, Xinyuan has not developed enough following among institutional investors knowledgeable about China real estate who could acquire shares when they are being sold cheaply.
Unrestricted Cash Balance surged to $916mm at 3/31. Of this about $200mm is likely to be used to retire the 2019 bonds. If Xinyuan meets its expectation of RMB 17Bn in contract sales and applies RMB 6.8Bn to new land acquisitions then the company is likely to enjoy significant cash accumulation over the course of the year. The company will be well positioned to deleverage and improve its credit quality, withstand unexpected market weakness, and take advantage of unexpected opportunities that may arise.
Book Value per ADS rose to about $13.97 from at 3/31/17. The company did not disclose shares outstanding at quarter-end, but I assume 64.3mm based on 12/31 shares of 65.7mm less repurchase of 1.4mm. Looking at contributions to the change in book value since year-end highlights the value being created through the share buyback.
The $0.38/share change in book value plus dividend is a more realistic measure of the value generated for shareholders in 1Q17 than the reported EPS (per basic ADS) of $0.12.
Selected Project Comments
- Zhengzhou International New City is the company’s most important project because it is part of a very large multi-phase development agreement with the Zhengzhou government that will be built over the next 3-5 years. Xinyuan cooperated with the government in developing a long-term plan for revitalization of that area and advanced funds for relocation of existing residents and upgrading of infrastructure. Related lands are sold through public auction, but the cooperation agreement provides Xinyuan with a price advantage and the government also manages the auctions to limit bidding competition. The 29.4% gross margin projection for Phase 1 provides a positive signal for the likely profitability of future phases. No units at Zhengzhou International New City were sold in 1Q, but the company said that presale permits have now been received for 2 parcels and another is expected in June. Presales of Phase 2 of the New City project are currently expected to begin in 3Q17.
- Sanya Yazhou Bay enjoyed fast sales in 1Q17 (22% of total GFA) after many quarters with little activity. Xinyuan has projected an excellent 35% gross margin from this project, but doesn’t earn any money until the units are sold. It’s a relief to see them moving.
- Brooklyn Oosten contributed 20% of contract sales in 1Q17 and 144 of the 216 units were delivered by 3/31. Unfortunately costs at this project came in above budget leading to a lower than expected gross margin (15% in 2016) and a legal dispute with the general contractor. The company believes it has accounted for the likely outcome of the dispute , but is reluctant to make any further comment until it is resolved. Oosten provided Xinyuan with significant intangible benefits by enhancing the image of the Xinyuan brand in China and establishing a foundation for success from future New York projects, but the financial return was modest.
Peer Comparison in my prior article explained why a Xinyuan share price around 65% of book value would be fair relative to similar companies. Updating for subsequent changes in share prices, analyst estimates, and company news:
Hong Kong listed companies report financial results semi-annually so a comparison of 2017 peer margins cannot be compiled until September.
Disclosure: The author is a Xinyuan shareholder and believes that greater public awareness of the facts in this article could be of benefit to himself and other public shareholders. Investors are encouraged to independently verify all of the key facts cited here and form their own opinions.