Xinyuan Real Estate: A Lot Of Risk To The Story

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Summary

  • Xinyuan recently announced the resignation of its CEO, and this comes shortly after the company appointed a new CFO.
  • There are reasons to like Xinyuan at today's price but there are definitely risk factors that need to be considered.
  • I hold a position in Xinyuan and I plan to stay long the stock.
  • This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

Xinyuan Real Estate (NYSE:XIN) is a company/stock that I have followed for years now, and, in my opinion, the market has never been truly sold on the story for this Chinese real estate company. As soon as sentiment improves and XIN shares gain momentum, the stock sells off due to some type of broader market concern.

ChartData by YCharts

Notice the steep hills and valleys over the last three years. This makes sense though, right? Management has consistently failed to effectively communicate their strategy and, to make matters worst, there has been a revolving door in the C-suite. It's hard to keep momentum going when there's no one giving people a reason to stay long the stock (please take notice, management).

After saying all of this, I'm long Xinyuan (and plan to stay long) because I believe that there's a lot to like about the long-term business prospects of this company, even if I have to dig up the details myself. However, make no mistake about it, there's a lot of risk to the story.

Risk To The Story

It would be a major understatement to say that an investment in Xinyuan comes with risk. This is a risky investment that, in my opinion, has become even risker so far in 2019.

(1) Who Is Running The Show?

It was recently announced that Lizhou Zhang would be stepping down from the CEO role due to "personal reasons" and that the founder of the company, Yong Zhang, would now be serving as both chairman and CEO. And let's not forget that Xinyuan just appointed Mr. Yu "Brian" Chen as its CFO in mid June 2019. A new CEO and CFO in a matter of a month seems like a lot of change, if you ask me.

As I have stated several times in the past, it's hard to convince the market that your stock is a good investment when there's not a consistent management team in place. Therefore, I believe that the lack of consistency in the management ranks is the No. 1 risk factor that should be considered/monitored.

(2) Debt And More Debt

Xinyuan's growth strategy has largely been fueled by debt and, as you can expect, financial leverage is a significant risk factor.

Source: 2018 20-F

As shown, the growth in debt has outpaced the growth in cash by a wide margin over the last five years. The debt figures are definitely significant, but I believe that Xinyuan has the ability to service its debt. But, at some point, the leverage has the possibility to turn into a real problem. As such, I believe that shareholders should closely monitor Xinyuan's debt balance over the next few years because there's such a thing as too much financial leverage, especially if market conditions continue to deteriorate.

The ever-changing management team and the company's growing debt balance are the two biggest risk factors, of course, in my opinion, but investors should also keep a few other things front of mind. For example, the Chinese property restrictions and the noise caused by the China-US trade war are two other risk factors that are coming into play.

Additionally, see the 2018 20-F linked above for the risk factors that were identified by management. However, it's important to also note that there are legitimate reasons to like XIN shares at today's price.

There Are Reasons To Stay Long

You would not be crazy to ask why I intend to stay long the stock after reading the last section. In my opinion, there are some legitimate reasons to be bullish about this Chinese real estate company.

(1) The Core Is Fine... Plus, There Are Some Kickers

Management's corporate strategy (yes, the strategy that they never seem to communicate/highlight) is geared around what they call "1 core + 5 auxiliary businesses":

Source: Investor Presentation, Sept 2018

Real estate is still the No. 1 priority, and rightfully so. And it helps the bull case that Xinyuan has been able to report solid operating results over the last few quarters. For example, Xinyuan reported Q1 2019 net income of $18.2M (compared to a net loss of $12.7M in Q1 2018) on total revenue of $469M (compared to $174M in the prior period).

Source: Q1 2019 Earnings Presentation

Even after factoring in the noise (Chinese property restrictions and the adoption of the new revenue accounting change), Xinyuan has been able to report strong operating results over the last year - definitely nothing to brag about but also nothing to trigger a sell rating either.

Moreover, I believe that the property management business has the potential to be a true hidden gem. It helps that management also is bullish about the subsidiary's prospects:

Our Xinyuan Property Management Company subsidiary has achieved a rapid growth these recent years. To further driving its development, we have applied to list the Xinyuan Property Management Company in Hong Kong. After the listing, we will continue to be the controlling shareholder in the fully consolidated company.

We believe that listing on such a high-quality platform, where many peer companies are listed, we benefit all of our shareholders. They also are pleased to be able to continue to deliver value to our shareholders with our dividend payment this quarter. Despite market and policy effects, we remain optimistic about our ability to achieve positive operating performance. We will remain focused on our core business and turn our competitive advantages and strengthen our market-leading position.

Source: Q1 2019 Earnings Transcript

The listing could be a catalyst for the stock.

Lastly, XIN shares are trading at attractive levels after the recent pullback.

ChartData by YCharts

Yes, the company is that cheap. I do not anticipate XIN shares trading at a reasonable valuation (let's say 7 or 8 times earnings) anytime soon, but the stock will likely return to normalcy later in 2019, if the company is able to continue to report solid results.

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. (Click the "EN" icon on the top right to get the English version of the website, if you have any issues with the link.)

Bottom Line

Don't over think it, Xinyuan is definitely a high risk/high reward stock to own, but I believe that the company is worthy of investment dollars. Yes, the growing risk factors - management shuffle, growing debt balance, and the ongoing trade war noise - need to be considered, but, as described above, there are legitimate reasons for shareholders to stay the course with Xinyuan. As such, I believe that investors with a time horizon longer than two-to-three years should treat pullbacks, especially if they are caused by a broader market selloff, as long-term buying opportunities.

Author's Note: I hold a Xinyuan Real Estate position in the R.I.P. Portfolio, and I have no plans to reduce my stake in the near future.

Additional disclosure: 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.

If you enjoyed our stock coverage, please consider joining the Going Long With W.G. marketplace service. We cover at least one new small-cap company each month and we regularly update our thoughts on past recommendations. Additionally, subscribers have access to a Live Chat feature that allows for one-on-one and/or group conversations. *Start your free trial today*

This article was written by

WG Investment Research profile picture
8.35K Followers
Our President and CIO is a CPA with experience in public accounting and the financial services industry. He earned his Master of Accountancy degree in 2008 and his B.S. in Business Management in 2007. He is also a Level III CFA candidate. He has been intrigued by the market from the start. Over the years, he has learned that long-term investing is a discipline that, if followed, will help contribute to building lasting wealth. As such, most of our articles will be about the investments that we plan to hold for at least 3 to 5 years, as long as the company's story does not change. As a Seeking Alpha contributor, our main goal is to write about the companies that are key to our portfolio with the hope of promoting discussion (for or against the investment) from others within the SA community.Please visit our website for more information about W.G. Investment Research LLC.

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.

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