Xinyuan Real Estate And The Adoption Of ASC606: Where Are We Now?

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About: Xinyuan Real Estate Co., Ltd. (XIN)
by: Elliott R. Morss

Summary

The prospect of a Chinese-US trade war has dimmed investor enthusiasm for Chinese equities.

Add to that the accounting changes XIN has made that has made it difficult to track its finances.

In this piece, the accounting changes are examined with conclusions drawn about how these changes will affect XIN's finances going forward.

Elliott R. Morss ©All Rights Reserved

Introduction

In the last few months, Xinyuan (XIN) has sold off sharply. And an important reason for this sell-off is the misleading downturn in quarterly reports resulting from the adoption of the ASC606 accounting method. Adoption of ASC606 delays the dates on which sales can be recorded. There is reason to wonder when the effects of this accounting change be fully registered. In what follows, recent before and after ASC606 data are examined. The conclusion is that the sale delays resulting from the accounting adjustment have been fully registered.

What ASC Does

I quote from XIN’s SEC reports:

A significant portion of the Group’s revenue is derived from real estate sales of development properties in the PRC. Prior to the adoption of ASC 606, the Group recognizes revenue using the percentage-of-completion ("POC”) method on the sale of individual units when:

  • (i) construction is beyond a preliminary stage; and

  • (ii) the buyer is committed to the extent of being unable to require a refund except for non-delivery of the unit; and

  • (iii) sufficient units have already been sold to assure that the entire property will not revert to rental property; and

  • (iv) sales prices are collectible; and

  • (v) aggregate sales proceeds and costs can be reasonably estimated.

A Review of Financial Reports for Recent Quarters

Table 1 shows XIN’s quarterly financials for the last 3 quarters in 2017 before and after imposition of ASC606 standards. It appears the biggest adjustments were in the 2nd and 3rd quarters. The 4th quarter results, usually XIN’s strongest, appear better with ASC606 than earlier quarters and better using ASC606 than when the POC method is used.

Table 1. - A Comparison of XIN’s Quarterly Reports (mil. US$)

Source: XIN’s SEC Reports

2018 Quarters

Table 2 provides financial data for the first two quarters of both 2017 and 2018. Earlier, XIN management estimated second quarter Contract Sales at $530 million so actuals were markedly better.

Table 2. – XIN 2018 Results (mil. US$)

Source: XIN’s SEC Reports

Looking Ahead

For 2018, XIN expects an increase in contract sales of about 10% and an increase in consolidated net income of 15% to 20% over 2017. For this to happen, the last two quarters will have to be quite good. But keep in mind, revenues that have not been reported because the switch to ASC606 will now start to be reported.

There is one other item that should improve the results in the last two quarters of 2018. Under ASC 606, to recognize revenue over time similar to the POC method, contractual provisions need to provide the Group with an enforceable right to payment. Historically, XIN’s contracts did not include an enforceable right to payment. But for all contracts executed starting from January 1, 2018, XIN modified certain terms to establish an enforceable right to payment for performance completed to date, including a reasonable profit.

In the above, XIN’s real estate developments have not been assessed and there could be positive or negative surprises there. However, very good results can be expected for the last two quarters because:

  • The delayed revenues will start to be reported and
  • There will not be further reporting delays because XIN has added an enforceable right to their contracts going forward.

Disclosure: I am/we are long XIN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.