I was generally pleased with the third quarter results for Xinyuan Real Estate (XIN). With most indicators pointing to an improvement in China's overall economy, I'm hopeful that the end of a very challenging business environment for Chinese companies is coming to an end. But, I'm not naive to believe that an improved Chinese economy can be equated to flipping a switch and having an improvement in business operations and operating results of Chinese companies occur overnight.
One of my recent quests has been to identify Chinese companies whose growth is tied to the growth of China's domestic economy, as opposed to Chinese companies whose business is tied to exports.
I've indicated that Xinyuan Real Estate was a company worthy of investment consideration. I've been anxiously awaiting the company's third quarter financial results which came out last week. The company's very low P/E, which today is 1.61, is, for me, an attention grabber.
While most of Xinyuan Real Estate's activities are China-based, the company has begun operations in the U.S. as well. But, I consider the company a "China play," and am not very enthusiastic about the long-term prospects for the company's U.S. business direction. But time may prove me wrong.
Xinyuan Real Estate's China activities consist of developing large-scale real estate projects targeting middle-income Chinese consumers. The company's focus has primarily been on what are referred to as China's Tier I and 2 cities. The company has targeted Chinese markets with a population of over 64.7 million in eight cities: Beijing, Hefei, Jinan, Kunshan, Suzhou, Zhengzhou, Xuzhou, and Chengdu.
Xinyuan Real Estate's Third Quarter Results
Xinyuan Real Estate's third quarter revenues increased 6 percent to $226.1 million from $213.3 million for the same quarter of 2011. This was an almost 11 percent decrease from revenues of $253.1 million for the second quarter of this year. Real estate development is not generally a business that can show quarterly improvements in revenues, or for that matter net income every quarter. One has to remember that the operational challenges in real estate development are not the same as manufacturing or selling a widget. So, all-in-all, I'm definitely pleased with the company's third quarter financial results. I believe that with China's economy improving, that the future for Xinyuan Real Estate only gets better from here.
Xinyuan Real Estate's contract sales were almost $230 million in the third quarter, a decrease of almost 11% from the same quarter of 2011, and an almost 11 percent decrease from the contract sales in the second quarter of this year. I'm not sure what to make of this, as I don't necessarily believe that these decreases are part of a long-term trend, but instead are indicative of the challenges of business in China over the past months and the operational aspects of real estate development.
Xinyuan Real Estate's selling, general, and administrative expenses as a percent of total revenues remained somewhat constant, 6.6 percent, compared to 6.7 percent for the same quarter last year, and 6.2% in the second quarter of 2012. The increase in these expenses is, I believe, primarily a result of decreased revenues for the quarter. They, I believe, are indicative of the inability by the company's management to adjust quickly to what are likely mostly fixed costs, as revenues declined.
The company's net income totaled $31.9 million, a 2.2 percent increase from the $31.2 million reported for the third quarter of 2011. But, net income decreased 54 percent from the $69.4 million of net income for the second quarter of this year. While not a consolation, the net revenue was in the range of the company's third quarter guidance.
Earnings per American Depositary Share ("ADS") $.44 in the quarter, compared to $.42, in the third quarter of 2011 and $.94, in the second quarter of 2012. These earnings per ADS track the changes in net income relatively closely.
I remain impressed by the company's strong cash position, which, as of the end of the September 30th quarter, was $608.6 million. The company has been using its cash, not only for repurchase of shares and dividends, but most importantly for land purchases.
In August the company acquired land in Suzhou totaling approximately 420,000 square feet for $42.6 million.
In September, Xinyuan Real Estate acquired the land use rights for its first project in Beijing, at a cost of $162.4 million. The development site consists of a total area of approximately 621,000 square feet in the city's Daxing District, between the city's fifth and sixth southern ring roads. The company indicated that its target customers will be first time home buyers, young couples, and commuters who work in downtown Beijing. The company indicated that it would build smaller-sized and affordable apartments on the development site.
A subsidiary of Xinyuan Real Estate, XIN Development Group, Inc., is proceeding with three U.S. projects. As a component of this strategy, on September 28th the company announced that it acquired a development site in the Williamsburg section of Brooklyn for $54.2 million. The company indicated that the Brooklyn site will accommodate an approximate 506,000 square foot residential condominium development, approximating 216 units of averaging 1850 square feet each. It will be interesting to see what impact Hurricane Sandy will have on the company proceeding with this project, due to the project's proximity to the Brooklyn waterfront.
The company also has luxury apartments for resale in Irvine, Calif., and 325 finished lots and 185 acres of raw land in the Reno, Nev., area. It appears that the company's strategy will be to principally market in China the California apartments, the Brooklyn condominiums and homes in the Reno area.
Previously I indicated I was comfortable with Xinyuan Real Estate's China strategy, but I was unsure as to how successful Xinyuan Real Estate will be with its U.S. business direction. The U.S. is a different business environment than that of China, and I believe that the U.S. will provide ongoing challenges for the company. While I believe that it's likely that the company will announce additional U.S. projects and acquisitions, I believe that its U.S. strategy may end up being a distraction from what I believe the company should be doing - focusing on real estate development in China's Tier 1 and 2 cities.
All-in-all I'm pleased with Xinyuan Real Estate's third-quarter results. With China's economy strengthening, I believe strongly that the improvement of the country's economic conditions will start to translate to more robust financial results for many companies. I expect this to start occurring in companies' financial results for the first quarter of next year. I strongly believe that Xinyuan Real Estate is well positioned to grow as China's economy continues to improve.
Awaiting Quarterly Results For Other Chinese Companies
With the continuing economic problems of the U.S. and Eurozone, it's appropriate to look at investments in "countries that are working." I believe that now is the time to take a look at Chinese equities, not from a short-term trading perspective, but instead from a medium- to long-term investment strategy, a strategy for the next three to five years.
With the Chinese economy likely having bottomed out, and with the valuations of Chinese companies that trade in the U.S. being very low, I believe that it's appropriate for investors to take a fresh look at Chinese equities that trade in the U.S. This I believe should be done not from a short-term perspective, but from a longer-term perspective.
One of my focuses here at Seeking Alpha has been on analyzing Chinese companies that meet a few general criteria. These include positive trends in revenue and income, low P/Es, companies that are focused on internal Chinese demand rather than export, and companies with good growth prospects for the future.
Some of the companies that I believe meet these criteria, that I've discussed in detail here at Seeking Alpha, and which I intend to comment on after they report their quarterly earnings, include:
Xiniya Fashion Inc. (XNY) designs, manufactures and sells men's clothing and accessories. For the quarter ended June 30th, the company showed an increase in revenue of almost 25% to nearly $25 million. But despite the increase in revenue, net income for the quarter was almost $3.2 million, a 43% decrease compared to the second quarter of 2011, due to primarily increased selling and distribution costs. My conclusion is that the company has already started reining in these costs, and that the likely decrease in these costs will be reflected in the company's third and fourth quarter results, making the company a definite candidate to be considered for investment. The company's P/E is 1.80.
China Carbon Graphite (CHGI.OB) is one of the country's leading wholesale suppliers of fine grain and high purity graphite, and a top overall producer of carbon and graphite products. Its revenues for the second quarter were $11.88 million, and its net income was $870,000. The company's P/E is 3.69.
Asia Carbon Industries' (ACRB.PK) principal product is carbon black, which is primarily used as a key raw material in the manufacture of tires. The future of Asia Carbon Industries' business is tied to the growth of the tire industry in China, and to the growth of China's auto industry as well. The company's revenues for the second quarter of this year were $13.195 million, which, on an annualized basis, is slightly more than the $49.12 million the company reported for all of 2011. The company's net income for the second quarter of this year was $1.87 million. The company's P/E is 1.19.
China Green Agriculture Inc. (CGA) produces and distributes humic acid-based compound fertilizers, other varieties of compound fertilizers and agricultural products. All of its products are certified by the Chinese government as "Green Food Production Materials," as defined by the China Green Food Development Center. For the first six months of this year, its sales increased 21% to $217.5 million, net income increased 27.5% to $42 million and the company had earnings per share of $1.56, which beat company guidance. Most importantly, the company provided guidance indicating that it would continue to grow during the rest of this year. The company has forecast revenues of at least $238 million, net income of at least $46.2 million, and earnings per share of at least $1.68 for the full year of 2012. The company's P/E is 2.30.
China Recycling Energy (CREG) provides environmentally friendly waste-to-energy technologies to recycle industrial byproducts for steel mills, cement factories and coke plants in China. Byproducts include heat, steam, pressure, and exhaust to generate large amounts of lower-cost electricity and reduce the need for outside electrical sources. The company's net income in the second quarter was $1.2 million or $0.03 per share, a decrease from $3.7 million, or $0.07 per share, for the second quarter of 2011. The company's P/E is 2.92.
China Automotive Systems (CAAS), through eight joint ventures in China, manufactures and sells power steering components and systems to China's automotive industry, and also exports to North America. The company is the largest power steering manufacturer in China's domestic market. For the second quarter of this year, the company's sales increased 2.8% to $80.4 million. For the second quarter of this year, China Automotive Systems' net income was $8.6 million, up from $7.2 million for the second quarter of 2011. The company's P/E is 7.02.
Investing in smaller-capitalization companies, as well as investing in companies in emerging markets (including China), is not suitable for all investors and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risks.
The companies mentioned above include smaller capitalization companies with operations based in China. All the companies mentioned trade in the U.S., are all U.S. reporting issuers and therefore subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors. Xinyuan Real Estate Co. is listed on the New York Stock Exchange, so this NYSE listing should provide additional comfort regarding disclosure and transparency for investors.
Disclosure: I am long ACRB.PK.