Xinyuan Real Estate: Down, But Not Out

Summary

• Xinyuan reported solid Q2 2019 results, but there are still some risks to the story.
• I do not believe that Xinyuan has a debt problem, but, in my opinion, this thought could change in short order.
• I hold a Xinyuan position, 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's (NYSE:XIN) stock is up over 11% so far in 2019, but XIN shares are still significantly underperforming the S&P 500 (SPY) over the last 8 plus years.

Data by YCharts

The poor stock performance has been a drag on the results for the R.I.P. portfolio, but, in my opinion, there are still reasons to stay long Xinyuan. Simply put, the stock is down, but it's not out.

The Results

On August 16, 2019, Xinyuan reported adjusted Q2 2019 EPS of $0.19 on revenue of $609.4M, which compares favorably to the year-ago quarter.

Source: Q2 2019 Earnings Press Release

There has definitely been some noise in the numbers related to the adoption of ASC 606, but, as shown, there is a lot to like about the Q2 2019 results. Highlights for the quarter:

• Contract sales declined by 20% YoY (from $633.9M to $507.4M)
• Total revenue increased by 71.3% YoY (from $355.8M to $608.4M)
• Gross profit came in at $159.2M (YoY growth of 45.5%) with SG&A expenses as a percentage of total revenue down by almost 3 percentage points (from 10.3% to 13.2%)
• Net income and diluted net earnings per ADS were $19.8M and $0.19, respectively, which were significant improvements from the Q2 2018 results (-$9.3M and -$0.10)

During the conference call, management spent a considerable amount of time giving investors an update on the foreign (i.e., non-China) properties, and I believe that the Hudson Garden and the UK projects have the real potential to be significant catalysts for the stock. Additionally, management mentioned that they applied to list the property management business in Hong Kong, which is a positive development for this company. Moreover, management also stood by their full-year 2019 guidance for contract sales (10% YoY growth) and consolidated net income (15-20%).

This all sounds good, right? It should, however, be noted that Xinyuan is still dealing with significant headwinds in China (property restrictions), and the foreign projects are not sure-fire wins (remember, the remaining units for the Oosten project are still unsold), so, in my opinion, I believe that Q2 2019 was a mixed bag for Xinyuan.

In my mind, the biggest takeaway from the quarter was the fact that management finally acknowledged that the company may have a debt problem.

Does Xinyuan Have A Debt Problem?

To start, companies like Xinyuan typically utilize debt to fuel growth, so it should come as no surprise that the company has a stretched balance sheet. However, there is such a thing as too much debt which is a position that Xinyuan is quickly approaching, of course, in my opinion.

During the conference call, management talked up the progress they made reducing the current portion of the debt, but it is important to also note that total debt was actually higher [by a lot].

Source: Q2 2019 Earnings Press Release

So, yes, current debt was down by over 30%, as described by management during the call, but long-term debt actually increased materially when compared to Q1 2019 (and Q4 2018). Management was asked about the growing debt balance, and this was Yu Chen's, CFO, response to an analyst question about Xinyuan's cost of financing and how the company plans to balance the use of equity and debt:

....It's still high. So, from the overall debt pile, our intention is to have the overall balance - bring it under control and reduce it in the next three to six months.

We'll achieve this through a few means. First of all, we will improve our performance by increase the profitability, improve the turnover, more cash generated coming from the operating activity. We'll use this fund to pay down certain outstanding debt.

As at this point, facing the current portion of the debt, which mature in the next 12 months, we are either laying down funding prepared for those debt payments. Or some of them, as at this point, we already pay it down. So, overall, you will see a decrease of the overall debt as well as the improve of the debt related ratio in a quarter or two.

We do need to strike a good balance between our equity shareholder and the debt holder. We want to maintain a track record and pay out consistent dividend to our equity shareholder, but we only do so by doing a careful cash planning and make sure that we have sufficient funds to not only keep the liquidity at our operation, but have all the funds prepared to deal with the maturity of our debt out there.

Overall, we'll need to strike this balance. As time passing by, when we improve our profitability and when we tap into further equity issuance opportunity, we believe that, in a few quarters, we will have a good balance between - a better balance between the equity investor and the debt investor.

The overall cost of the borrowing or the overall cost of the capital will reduce in two to three quarter.

It [kind of] sounds like management has a plan, but the proof will be in the pudding. As I previously described, Xinyuan's debt load is a risk factor, but it is not yet a concern that makes me want to sell my XIN shares. Management will, however, need to materially improve Xinyuan's cost of financing prospects and rightsize the balance sheet or I may significantly reduce my stake in the quarters ahead.

Valuation

Xinyuan is cheap based on several different metrics.

Data by YCharts

I am really starting to question if Xinyuan's valuation really matters or not. Remember, this company's stock has been cheap for years. XIN shares are without a doubt attractively priced, but it will be up to management to finally change the narrative before the stock will have any chance to trade at a reasonable valuation.

Let's also not forget that management continues to run a shareholder-friendly company. The board announced another $0.10 quarterly dividend and management bought back 1.4M ADS in Q2 2019. Buying back shares at current levels make a ton of sense.

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

There is a lot to like about Xinyuan's Q2 2019 results and management's commentary, so I plan to stay long the stock. I believe that Xinyuan has several catalysts - the U.S. and UK properties, a positive change to sentiment, lift in restrictive policies in China, capital return story, etc. - that have the potential to create a significant amount of shareholder value over the next two-to-three years.

Investors should not run out and purchase XIN shares tomorrow, but I do believe this company has great business prospects, even with the challenges created by the Chinese government. The stock is down, but it's not out.

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.