Xinyuan Real Estate (XIN) reported second quarter 2011 earnings which far surpassed its own expectations as well as the few Wall Street analysts who cover the company. Revenues were $182.7m in the second quarter which almost doubled the $91.8m recorded in the first quarter. This compares to XIN’s prior guidance of $155-160m and even lower analyst consensus of $139m.
Net income grew at a higher rate as operating expenses only expanded marginally on a sequential basis. Second quarter net income came in at $31.8m, far above the company’s prior guidance of at least $20m. On a percentage basis, net income grew at 172% over first quarter levels. Earnings per share equated to $0.40 on a fully diluted basis which almost doubled Wall Street consensus of $0.22 per share. First half 2011 net income alone totaled $42.8m vs. XIN’s current market cap of $154m at recent share prices around $2.00 per share.
On top of Xinyuan's impressive second quarter, guidance for Q3 is even better. The company now expects third quarter revenues to increase to $215-235m, or roughly a 20% sequential increase. Once again, XIN only gave a minimal range for net income such that the company believes it should exceed $35m in Q3. Assuming this minimal sequential earnings growth is achieved, it would represent earnings growth of approximately 10% in the following quarter. Since much of Xinyuan’s operating costs are fixed, net income growth is likely to exceed revenue growth as evidenced in Q2.
As a result of higher than forecasted Q2 and Q3 expectations, Xinyuan also raised its forecast for 2011. Annual revenues are now expected to range between $740-780m. On a net income basis, the company expects to earn at least $100m for fiscal 2011 which exceeds prior guidance by 33%. Relative to XIN’s current market cap, its current price to earnings ratio (PE) is only 1.5x current year’s earnings.
Some investors may wonder why XIN is valued so low while others who have been tracking sentiment probably have a better understanding in regards to market valuations. Due to recent accounting issues among a handful of U.S. listed Chinese companies as well as plenty of unproven allegations, investors have discounted nearly all other Chinese stocks. The obvious question is which companies are less likely to have issues since it would be a fallacy to assume all Chinese companies are fraudulent.
Thus far at least, most of the problematic Chinese companies have been small reverse merger stocks which use less reputable investment bankers and corporate auditors. Xinyuan does not fall into this category however. The company was brought public in late 2007 in a normal NYSE IPO with Merrill Lynch and Deutsche Bank as lead underwriters. It also uses a big four auditor Ernst & Young. While these factors are no guarantees Xinyuan is completely problem free, it is less likely large global reputable firms would risk its name and prestige on a questionable small Chinese company. In contrast, reverse merger companies typically bypass the normal vetting process by large investment banks.
Even assuming Xinyuan is a good company currently valued at extremely low valuations, it is no guarantee the stock will be a good investment in the short or long term. With investor sentiment so negative, Wall Street may continue to ignore XIN’s actual business as it has done in the past couple of years. Of course if sentiment were to change in the future, low valuations often yield high returns once perception normalizes towards more reasonable levels.
Luckily for current investors, Xinyuan has been proactive in returning shareholder value lately. Late May, the company announced a $0.10 dividend and a $10m share repurchase plan. The dividend was paid in early June, and up until its Q2 earnings report, almost 600k shares have been repurchased for $1.26m. At the current share price, another 4.4m shares could be repurchased under the current authorized plan which would represent a potential 6.5% reduction in XIN’s diluted share count and over 10% of the share base not owned by corporate insiders. Assuming the $0.10 dividend is made only annually, it would still represent a yield of 5%.
The more important factor for investors to consider is that Xinyuan’s recent proactive actions are sustainable if not augmentable. The recent announcement amount to only $17.5m. That’s just half of estimated third quarter net income and only a fraction of the estimated $100m in 2011 earnings. With $407m in cash vs. $318m in total short and long term debt, XIN is far from a distressed situation. The company also has nearly $700m in property under development and a book value around $7.35 per share.
Until investor sentiment in the U.S. shifts more favorably towards Chinese stocks, Xinyuan may very well continue to trade in a rut much like other Chinese companies listed in the U.S. There is also additional negative perception since Xinyuan is a property developer operating in an environment where the Chinese government has been trying to contain price appreciation. Although general central government policy is a current headwind for XIN, the company does have an advantage in that it operates in tier two cities and not first tier cities where the government considers property appreciation to be most speculative. With current valuations so low by any historical standard and the company proactive in returning shareholder value, investors may have an additional bonus as they wait for negative sentiment to shift.
Disclosure: I am long XIN.