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posted on 17 August 2016

Xinyuan Real Estate: Growing Without Increasing Debt

by Elliott Morss, Morss Global Finance

Xinyuan Real Estate: Positive News in a Risky Business

Introduction

The second quarter results from Xinyuan (NYSE:XIN) sound good.

xinyuan.re.logo

Table 1 summarizes data from CFO Liu's statement at the earnings call. Sales are up. Area sales are up but not by as much (possibly because a greater portion of more expensive properties sold). Selling prices are holding up and Koneko Research has reported primarily favorably on prices where XIN has properties. Revenues and profits are growing steadily. And in part a result of share buybacks, earnings per ADS have also jumped.

Table 1. - XIN Second Quarter Results

xi1Source: XIN

So overall, things look good. But the devil is in the details that I cover below.

Dividends and Buybacks

XIN has definitely made many US investors happy by its dividend doubling (from 5 cents per quarter to 10 cents) and via its buyback actions. The dividend jump means the annual yield has increased to 6% based on XIN's $6 price. And with 68,164 ADS outstanding, this quarterly dividend payment of $6.82 million is at what should be a sustainable payout ratio (6.82/27.8) = 24%.

XIN bought back 9 million shares in 2014, 1.1 million shares in 2016 and another 1.4 million shares this quarter. That means that since the end of 2013, XIN has reduced the shares outstanding by 14%.

The dividend increase and buybacks coupled with good performance, should be enough to attract more investors and cause the stock price to rise. But it comes at a cost: the funds required for the dividend jump and buybacks in the second quarter cost approximately $14 million. And that is $14 million not available for real estate development.

Real Estate Development is a Risky Business

A quick aside on real estate development: we know that real estate prices go up and down and it is risky/tricky to predict the future. But there is another part of real estate development that also makes it risky - the time phasing of activities. Developers have to:

  • identify properties to develop,

  • raise money,

  • get approvals to build,

  • building

  • sell and

  • phase cash flows in a way to have funds when needed.

Some allowance has to be made for contingencies, but quite clearly, if there is an unexpected delay somewhere after construction payments are made, there can be serious cash squeezes. XIN's Sanya development is a good case in point. Last quarter, XIN reported that real estate sales in Sanya for all developers had been stopped by a local government edict. That meant sales were suspended after only 2% of the XIN's properties there had been sold. That meant approximately $200 million in Sanya sales were delayed. Rest assured, those monies had already been programmed for other uses and the delay had to have been problematic for the company.

These problems develop all the time. For example, Chinese law requires that tenants living in a development area must accept a developer's offer to move before the development can move ahead. These negotiations can take quite a while. When I was working with Western developers in Shanghai a number of years back, they would not put any money into a development project until all the tenants had moved out.

The good news: CFO Liu did not mention the Sanya project in his presentation. But just received confirmation from XIN management that "Sanya sales activity has resumed in Q2 so there should be more normalized sales activity going forward." A reflection that sales have started up is the 4,200m2Sanya sales in the second quarter.

Table 2. - XIN Sales (m2000)

xi2Source: XIN

Inventories and Debt

CFO Liu reported that even with higher sales, properties under development did not fall and indeed were up slightly in the second quarter ($2.08 billion against $2.04 billion at the end of the first quarter). And XIN was able to keep the inventory up without increasing debt. In fact, as indicated in Table 1, debt has fallen a bit since the end of the first quarter.

Table 3 provides data on how selling prices have changed on XIN's property inventories. The properties are ranked by the amount of property yet to be sold. The properties where average selling prices have fallen are marked in red. Keep in mind that the individual prices do not necessarily reflect what has actually happened: most projects have a range of property types at different prices and price changes might reflect different weightings of what actually sold. However, the overall numbers are probably indicative of reality. And it appears prices have fallen 10% since the end of the 2nd quarter in 2015 and by 1% since the end of March.

Table 3. - XIN Selling Price History

xi3

Source: XIN

Borrowing Costs

When asked about interest rates, CFO Liu replied: "we do expect more favorable interest rates in the second half of this year." When asked about refinancing, he hedged. I take his "hedge" to mean new debt will benefit from lower rates, but it might not pay XIN to refinance existing debt.

It is interesting to gauge what sorts of borrow cost savings might be realized. XIN annual reports indicate XIN made $187 million interest payments in 2015. At the end of the 2015, its debt was $1.133 billion. That suggests an interest cost for the year of 16.5%. If that average could be reduced by 4 percentage points, the savings would be almost $23 million. That is significant when you consider XIN's profits this quarter were $27.8 million.

XIN's "New York Obsession"

Start spreading the news, I'm leaving today.

I want to be a part of it, New York, New York.

These vagabond shoes, are longing to stray

Right through the very heart of it, New York, New York.

I wanna wake up, in a city that doesn't sleep.

And find I'm king of the hill, top of the heap.

These little town blues, are melting away.

I'll make a brand new start of it, in old New York.

If I can make it there,

I'll make it anywhere.

It's up to you, New York, New York.


It is eminently clear that with an NYSE listing and three projects under development in the New York City region, XIN wants to "make it in New York."

When I interviewed CFO Liu in 2015, he reminded me:

"Did you know that several of our senior staff has a Western orientation? I got my MBA from Cornell and John Liang, the head of our New York office got his MBA from Wharton. In addition, the Chairman's son is currently an undergraduate at Columbia."

Okay. But NYC is a tough market: there are huge real estate developers with deep pockets regularly reviewing all possible developments there....

One would think that with XIN's connections in China, where the GDP growth rate exceeds 6%, and there is a growing middle class looking to upgrade their housing, XIN would be able to find more profitable projects there....

Conclusions

Right now, it appears XIN has all phases of real estate development in sync. Inventory is holding up while the debt is not growing. Sales are growing as is net income. In addition, the dividend increase and stock repurchases should attract new investors.

And like the giant Brookfield Asset Management (BAM), XIN has realized that property management can be a steady income earner.

XIN is in position for its next big step: to tap into the huge global real estate funds - Carlyle, Goldman, JP Morgan, etc. And for that purpose, having projects in NYC should help.

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