China's Xinyuan Real Estate: An Undervalued Long Opportunity

| About: Xinyuan Real (XIN)
Despite successive cooling measures in FY 2010, China’s developers continued to achieve spectacular sales growth. On average, the actual sales growth in 2009/2010 was 41% i.e., 15% above their original sales target (see Figure 1), reflecting strong property demand in China. The developer-set 2011E sales growth target is around 20% year-on-year, mainly on higher volume sales, rather than higher prices (see Figure 2).

Figure 1: China’s developers continued to fetch strong sales growth in FY2010 even with successive cooling measures

click to enlarge

Figure 2: China’s developers targeting a 20% sales growth target

China’s property market may start to see a soft landing this year, meaning flat growth in property prices (or no significant price plunge), with better volumes. We believe China’s government can allow stabilizing property policies because the year-on-year property price growth rate has declined in the past few months (compared to accelerating in early 2010E) and is down to 8% year-on-year growth in the last month (see Figure 3).

Figure 3: China’s property prices growth rate in the 70 large-and medium-sized cities

In addition, the government can still contain property speculative demand by:
1. Existing tightening policies such as restrictions on home purchases and mortgage tightening on second and third homes purchases
2.Raising interest rates and RRR to continue the shift from loosening to stabilizing monetary policies; this should help cool the overheated property market thanks to less credit and higher interest rates, and
3. Q2 2011E property supply will be abundant considering the abundant land acquisition in late 2009 and early 2010. This abundant supply will contain property prices and reduce the probability of further tough property tightening. The government will also build 10 million 'economy-style' houses in 2010E, thereby diminishing discontent from people who cannot afford housing.
•The property sector’s value is emerging. According to Merrill Lynch research, the 2011E PER valuation for the whole property sector is trading at around 10x 2011E PER, much lower than the average of 19x.
Xinyuan Real Estate (NYSE:XIN) is trading around 3x 2011E PER, according to consensus estimates. The historical PER highlights that the company is running more than 70% below the average rate of 14.7x. I think the policy risks have already been discounted too much. The shares are trading at a deep NAV discount of more than 50%.
1.Stronger-than-expected property tightening policies
2.Stronger-than-expected property price decline
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.