Xinyuan Real Estate: The Path Is Becoming Clearer

Summary

• Xinyuan's stock has performed well so far in 2019, but I still believe that XIN shares have room to run.
• Xinyuan reported strong Q4 2018 results that were well above the numbers that were reported in the year-ago quarter.
• I am long Xinyuan, and I plan to get longer in the near future.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Get started today »

Xinyuan Real Estate (NYSE:XIN) has been one of the best-performing stocks in the R.I.P. portfolio. The stock is up over 28% this year, and it is outperforming the S&P 500 (SPY) by 17 percentage points.

Data by YCharts

While there is definitely risk to the story, I believe that Xinyuan has the potential to be a great long-term investment at today's price. Moreover, it helps the bull case that the company's most recent operating results showed that Xinyuan is well-positioned for 2019.

The Latest, The Story Remains Intact

On February 15, 2019, Xinyuan reported adjusted Q4 2018 EPS of $1.15 on revenue of $1.08B, which compares favorably to the adjusted EPS of US$0.50 on revenue of US$725.66M reported in same period of the prior year.

Highlights from the quarter:

• Contract sales decreased by 12.1% (to US$724.0M) when compared to Q4 2017
• Total revenue increased by 49.1% YoY (to US$1,081.8M) and gross profit came in at US$310.2M (a YoY increase of 72%)
• Net income increased by 194.4% (to US$104.2M) when compared to Q4 2017

These results were even more impressive after considering the fact that Xinyuan is still facing significant headwinds in its home country (i.e., Chinese government restriction policies). The contract sales numbers are not great but, when taking a step back, they are not real concern [yet] either.

Additionally, anyone that follows me here on Seeking Alpha knows that I believe that Xinyuan's stretched balance sheet is a major risk factor. While the Q4 2018 balance sheet figures were nothing to brag about, I do believe that management is slowly putting this company in a more-manageable financial position.

(US$ - in thousands)	31-Dec-18	31-Dec-17	$ Chg	% Chg
Cash & cash equivalents	772,367	894,551	(122,184)	-14%
Real estate properties under development	3,804,555	1,996,001	1,808,554	91%
Total current Assets*	6,613,992	5,070,212	1,543,780	30%
Accounts payable	780,576	690,839	89,737	13%
s/t bank loans & other debt	43,711	247,758	(204,047)	-82%
Deferred tax liabilities - current	223,888	-	223,888	na
Total current liabilities*	5,279,591	3,674,819	1,604,772	44%
l/t bank loans	720,039	11,019	709,020	6435%
Other long-term debt	1,040,455	1,404,814	(364,359)	-26%
Total long-term debt	1,760,494	1,415,833	344,661	24%
Current ratio	1.25	1.38		-9%
Net debt	1,031,838	769,040	262,798	34%

Click to enlarge

Source: Table created by author; data from Form 6-K

* - There are other items that are not captured in the table above (I included only the items for purposes of looking at cash, debt, the new deferred tax liability, and the current ratio). Please see the full balance sheet for additional detail.

Observations:

• The cash balance is down, but real estate under development increased almost 100%
• The company has a significant deferred tax liability that impacted the current ratio. However, Xinyuan still has a current ratio over 1
• The net debt balance increased YoY, but, given the significant increase in real estate under development, the movement is reasonable

Simply put, Xinyuan does not have a terrible balance sheet, but management still has some work to do.

Another item that stuck out to me was the fact that the Oosten project (one of the U.S. properties) stayed status quo, as only US$8.8M of revenue was recognized in 2018. The move outside of China, especially the U.S. properties, is a major part of the investment thesis, in my opinion, so the Oosten update (or lack thereof) is not great news. The company did announce that the property in Flushing, New York, was progressing well, but I believe that it is looking more likely that the international businesses will take a long time to play out.

However, any way you slice it, there was a lot to like about Xinyuan's most recent operating results. 2018 was a tough year, but it was also a period of time that management showed the ability to navigate this small company through significant headwinds. It is also important to note that management guided for a strong 2019 - i.e., contract sales growth of 10% and consolidated net income growth of 15-20%.

The Accounting Change, The Path Is Becoming Clearer

As previously described, the adoption of the new revenue standard, i.e., ASC 606, largely shifts the recognition of sales/profits. Therefore, the significant YoY growth for Q4 2018 is not telling the whole story. A perfect example of this is shown in a review of the quarterly data for Q4 2018, Q3 2018, and Q4 2017.

Source: Form 6-K

As shown, total revenue was higher by 49% and 82% YoY and QoQ, respectively. Xinyuan is, however, not actually performing that well. To this point, now, consider the company's revenue growth on a full-year basis.

Source: Form 6-K

Xinyuan's total revenue only increased by 12% YoY for fiscal 2018. Therefore, investors will need to let the ASC 606 impact play out over the next few quarters before getting too excited/nervous, because there will be some noise in the numbers.

However, the path is becoming clearer. The company's Q4 2018 results were good, but, if you ask me, investors should wait before making any real investment decisions. In my opinion, investors should closely monitor the quarterly results in 2019 before getting too bullish/bearish.

Risks

There are risks that come along with investing in a small-cap Chinese real estate company like Xinyuan, so it would be wise for investors to first familiarize yourself with the company (and its history) before deciding to purchase shares. To learn more about the company, a good starting point would be to review Xinyuan's website.

Another risk factor is its high debt balance, which has been substantially increased in the last few years. I consider debt as a necessary evil for real estate companies, including Xinyuan, but, at some point, this company will need to improve its balance sheet by getting a handle on its financial leverage. As such, an increasing debt balance is a risk but not [yet] a significant risk, in my opinion.

Bottom Line

Xinyuan ended fiscal 2018 with a bang, as I rightfully predicted after reviewing the company's prior period results. The accounting change has made it hard (or should I say "nearly impossible") to get a good feel for Xinyuan's upcoming results. However, I believe that there is a lot to like about this small Chinese company as it enters a new fiscal year. The government restrictions are greatly impacting operating results, but, in my opinion, most of the risk is priced into the stock.

The blockchain buzz has quieted down, which is good news, in my mind, but I still believe that the technology business could eventually be part of the story (no time soon, in my mind).

This company is paying you to be patient (another quarterly dividend of $0.10 per ADS was announced) so I believe that shareholders should stay the course with Xinyuan in 2019.

Author's Note: I have no plans to sell my XIN shares in the near future. For full disclosure, I plan to add to my position before the upcoming dividend ex-date.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

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.