Tuesday, December 6, 2011

Comparing P/E Ratios Among China Property Developers

In our continuing effort to try to understand the very bizarre valuation of Xinyuan Real Estate, we want to delve further into valuations of Chinese property developers.  Here is a chart comparing P/E ratios among a a diverse group of Chinese property developers.

As can be seen in the chart, the price/earnings ratio of Xinyuan Real Estate (NYSE:XIN) is at the bottom. Which begs the question "why"?  Maybe looking closer at the financial statements of Yuexiu Property (123:HK) will give us a hint, since it has a similar P/E ratio to XIN (1.7 vs. 1.5).

Yuexiu has a price/sales ratio of 1, while Xinyuan has a price/sales ratio of 0.2.  Yuexiu is also trading at around an 50% discount to book, while Xinyuan is trading near an 80% discount to book.  Yuexiu has about 3.5 billion yuan in cash and equivalents, compared to around 23 billion yuan in liabilities.  This seems to be the most significant metric.  Almost all of Yuexiu's assets are tied up in its property investments.  Xinyuan, on the other hand, has about 2 billion yuan in cash and equivalents (not including restricted cash), and less than about 2.7 billion yuan in liabilities.  So there's a huge difference in strength of the two companies' balance sheets.  A significant downturn in the real estate market could quickly wipe out Yuexiu, but would probably only make a small dent in Xinyuan.

So why is Xinyuan trading like it is about to go out of business?  Previously we have discussed whether concern over fraud is to blame.  This is an unsatisfactory explanation, as XIN has paid a dividend, has a Big 4 auditor, went public through an IPO and has a long history of operation, and there is very little short interest in the stock.  It is also less fraud-prone than CHLN simply by virtue of these same criteria, nearly all of which CHLN flunks.  It should be noted that CHLN is the only company in the list above that does not pay a dividend, which makes its significantly higher P/E ratio even more baffling, and it consistently misses earnings estimates while XIN consistently meets them.  CHLN also has a much higher short interest (over 1.3 million shares vs. 250k shares short) on a much smaller float than XIN. 

There doesn't seem to be a satisfactory explanation other than the technical explanation we have given in the past.  If a property bubble exists in China and leads to a serious downturn in the real estate sector, the valuations seem even more distorted, as XIN has one of the strongest balance sheets of all the real estate companies, and would be much more likely to weather a difficult market environment.  Most likely, the valuation disparities will begin to correct over the coming year, either with XIN rising significantly or valuations for other Chinese real estate firms falling as the situation deteriorates, or some combination thereof. 

Disclosure: Long $XIN

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