Thursday, November 10, 2011

Xinyuan Real Estate - Fundamentals

In our previous posts on Xinyuan Real Estate (I, II) we focused on the interesting technical situation $XIN was in.  Namely that there was a descending triangle dating back to the IPO in 2007 that can be seen on a log chart, which has beaten down every major attempt at a rally in this stock.

As you can see, we're sitting pretty close to the key line today, as $XIN is currently trading at 1.94.  If $XIN does manage to break through the 200 MA and the descending triangle, there really would be huge upside potential in this stock, and one would anticipate volume would show up as well.

But what about $XIN's fundamentals?  First we should update the figures for EPS and book value per share given the Q3 earnings report released today.

$XIN reported $0.42 in earnings per share today, making their trailing EPS $1.27/share.  This means with the stock trading at 1.94 the P/E ratio is a whopping 1.53.  What about book value?  With the latest report there is $7.94 in book value per share.

On the conference call Tom Gurnee, the CFO, said he is "wracking his brains" trying to figure out why the market gives $XIN such a low valuation, when it has paid a dividend, is buying back shares, is trading well below book value, and has consistently made money and is increasing revenues and cash and decreasing debt.  As Matthew Larson from Morgan Stanley asked on the conference call this morning, "So I mean you’re getting an entire business for free" after noting that $XIN's net cash is greater than its market cap.   Larson said "I don’t really understand other than the fact that it’s a too strange investment world we’re in."  Could not agree more on that point.

The two things that were identified on the call as possible reasons for a low valuation were (1) fears of a China property bubble, and (2) fears that there is accounting fraud at $XIN.  There are several reasons why neither of these fears justify such a low valuation.

Let's take China property bubble first.  For one, as Tom Gurnee noted, $XIN is trading at a much lower multiple than other Chinese real estate firms.  While not an exact comparison to $XIN, $EJ, a China real estate services provider, is currently trading at a P/E multiple of 48.51.  As an aside, if you were concerned about a crash of the China housing bubble, a Long $XIN/Short $EJ play might make sense here.   Even more bizarre is that China Housing and Land Development, Inc., $CHLN, a Chinese microcap that came public as a reverse merger and that does not have a big 4 auditor, is trading at a P/E multiple of more than 4 currently, and has a better price/book than $XIN.  So I think we can rule out China bubble fears as the cause of $XIN's low valuation. 

What about potential for accounting fraud?  Again, it seems the comparison with $CHLN should raise questions about this explanation as well.  The risk of fraud is arguably higher with $CHLN, yet it trades at higher multiples than $XIN.  $XIN has a big 4 auditor, came public on the NYSE through an IPO, and has paid a dividend and plans to pay an annual dividend. If $XIN is faking the cash on the balance sheet, why would it buy back shares and pay a dividend?  The dividend and share buyback, along with the big 4 auditor that has audited several years of financial statements now, seems to suggest low risk of fraud.  Plus, short interest on this name is virtually non-existent, another indicator that there are not "rumors" of accounting fraud at $XIN.   

I think the only explanation that makes any sense for the low valuation of $XIN right now is technical rather than fundamental.  The descending trend line dating back to the IPO in 2007 has weighed down on this stock, and prevented any real price appreciation.  A lot of people bought this stock at much higher prices in 2007, and then again with the ramp up in 2009, such that there are a lot of bagholders that have continued to sell throughout the last four years and weigh down prices, and the descending triangle trendline basically serves to weed out every last one of those bagholders before the price can begin to appreciate.

I know this explanation will not satisfy many $XIN enthusiasts who are basically fundamental investors who see a great bargain here.  Fundamental investors tend to disregard technical analysis, but here a simple look at the chart dating back to the IPO in 2007 shows plainly that the trendline has weighed this thing down.

Once this trendline is broken (or simply comes to an end), the valuation of $XIN may begin to return to a somewhat reasonable one.  Until then, the trendline, and not vague concerns about a China bubble or accounting problems, seems to be the only real explanation for the price action here.

Value investors, take comfort.  It seems the trend line is due to be broken shortly, either in the next couple weeks with a break following earnings and/or analyst reports/upgrades, or in the next few months as the triangle narrows so much as to be unsustainable.


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