Robert Hsu was one of the louder cheerleaders for the first wave of the crazy Chinese bull market a few years ago, so it should come as no small surprise that he’s out leading the charge again — today, in a teaser for his China Strategy newsletter, he’s telling us that his latest pick, issued last night, is a “real estate juggernaut in the fast-moving China real estate market that’s set to double my readers’ money.”
And the argument is basically built on a repeat of his recent success in touting E-House (EJ), another Chinese real estate company, and the one that led the charge for listing similar firms on the US exchanges a few years back. If he indeed recommended EJ at the bottom, or near the bottom, back in March, his readers would indeed be sitting pretty — but of course, he also touted EJ several times when it was trading at prices above where it is today, this was an IPO in late 2007 that caught the end of the spectacular Chinese market move and spiked up to $35 or so before going more or less straight down to the $4 the shares hit last November and rebounding to around $20, where you could buy it today if you so chose.
But we’re not talking EJ here today — we’re talking about his follow-up, the stock that he says presents the same kind of opportunities now as EJ did six months ago, a chance for a huge profit.
“The biggest and boldest opportunity that is presenting itself right now is in the real estate sector, as China continues to flood the sector with easy money to inflate the real estate prices and grow the country’s economy.
“And our 240% gains in E-House since March not only proves that China’s stimulus plan is working like gangbusters … but also means that our next real estate winner should grab similar profits.”
He lays out his brief argument for why Chinese real estate is doing so well …
“Thanks to China’s easy money policy, real estate prices are continuing to rise—especially in the priciest Chinese real estate market of all—Hong Kong, where prices have risen an incredible 13% year to date.
“The buying binge has been driven by the same factors that drove the U.S. housing market to new heights: Limited supply, low mortgage interest rates, and low down payments of 20%!”
So that’s the backdrop — what’s the company?
“… our newest housing play has not only doubled its revenues and tripled its income over the first quarter but has also raised its guidance for the rest of the year—the very same factors that drove E-House to new heights!”
What else do we learn? We’re told that this is a “$5 stock”, and we get a few more clues …
“This little-known real estate play is a fast-growing national property developer in China’s second-tier cities—those that have a population size between two million to 10 million.
“Over the years, the company has successfully expanded its network to cover more than 34 million people in six Chinese cities — Chengdu, Hefei, Jinan, Kunshan, Suzhou and Zhengzhou. As a result, it was the number-one property developer in Zhengzhou from 2004 to 2006.
“As you’ll read in tonight’s China Strategy, the company mainly focuses on gearing its projects toward China’s growing middle-class by developing large-scale residential communities, mainly high-rise condominium buildings.
“In addition, the company constructs other developments like retail outlets, leisure and health facilities, and schools.
“As if that weren’t enough, the company also provides property management services and other real estate-related services to its customers.”
And actually, that’s starting to ring some bells now. I think I know who we’re dealing with — let’s see if there are a few more specific clues to confirm:
“… the company has tripled its revenues and net income in the second quarter of 2009.
“… top institutional investors and mutual fund managers like those at Franklin Resources, Fidelity, FMR, and others see this company, as I do, as a repeat of the E-House story—and own millions of dollars worth of shares in anticipation of the company’s 3rd quarter earnings report.”
So … starting to sound familiar? Looks like this is a stock that I wrote about for a different Robert Hsu teaser back in the beginning of the Summer, Xinyuan Real Estate (XIN)
And poor XIN is one of the few Chinese stocks that had a lousy Summer — actually XIN and EJ were traveling at much the same trajectory until about the time that HSU last teased XIN, and since then they’ve diverged significantly, with XIN dropping about 30% and EJ off to the races.
Does that mean that XIN will catch up? Well, it’s certainly an interesting company, a real estate developer with a nice little niche, but it’s not exactly the same as EJ, which is largely a services and brokerage firm, not a real estate developer (that’s why EJ has a nice 25% profit margin, and XIN recently has lost about 25 cents for every dollar of sales).
Xinyuan may indeed be getting down to bargain prices, if you are confident that their mid-tier cities will keep growing and that their condos will keep selling (Xinyuan is largely a developer of middle-class high-rise condo buildings) — they actually have to buy land rights and invest heavily to build new developments, so when prices dipped and things weakened they couldn’t exactly turn on a dime to cut costs and get more efficient, but it does appear that they tried, and that they’re doing better now that the housing market again appears healthy in China. I noted that they were trading at a pretty small multiple of book value back in early July, and now they’re trading at a discount to book value, so probably some investors don’t believe that their inventory is as valuable as they claim.
So, as I mentioned, XIN did indeed cut costs in the Spring — they shut down their marketing, and paused some development, but I think the snap back in the market really caught everyone by surprise with its speed, most of these companies were really preparing to hunker down and survive the storm and, in Xinyuan’s case, at least, suddenly turned around and started seeing sales growth again by the time the second quarter was well underway. You can read their conference call transcript following last quarter’s earnings announcement, and it’s quite positive and optimistic.
This is how management saw things as of about three weeks ago:
“The opportunities for Xinyuan to expand our current footprint are growing given the recent improvement in demand and with the positive effect of government initiatives. Our unique business model, which focuses on creating large-scale, high quality, affordable developments with quick asset turnover, should allow us to take advantage of these opportunities and generate additional growth in the future. We are well positioned as we move forward with a leaner cost structure, solid cash position, pipeline of growth opportunities and a strong management team.”
And their net income and revenue did come close to tripling in the most recent quarter, as teased — but that was sequentially, compared to the extremely weak first quarter of the year. If you look at the year-over-year growth, it’s not nearly as impressive (revenue year over year grew about 5%, net income actually fell substantially, by about 70%).
So … essentially what Xinyuan does is develop huge residential complexes, and they have designed a process for building and selling those complexes that they think is more efficient and effective than is typical — which seems to mostly mean that they pre-sell a large portion of their units, they use standardized designs as they can, and they build pretty quickly, putting up sometimes very massive complexes in often less than two years, and starting to book sales just a couple months after construction begins.
But this is still an area that, though probably more streamlined, is not altogether different than US real estate development — you have to plan now for the houses you want to sell in several years, so you can tie up the land, get the permits, plan and design, start to build, and sell the units. That always leaves a certain amount of vulnerability to the vagaries of fluctuating markets — if you’ve pre-sold a third of a development and are just underway with construction, what do you do if jumping commodity prices or falling real estate prices make the rest of the development suddenly look unprofitable? That’s a question a lot of developers around the US had to ask over the last couple years, as some of those luxury condos under development quietly became more modest apartment buildings … if they were finished at all. Xinyuan’s “non-speculative” strategy of permitting, pre-selling, and building rapidly to make sure they have a quick turnover does reduce the risks, but, as we saw in the first quarter of this year when things were falling apart, it doesn’t eliminate them.
I certainly understand the argument that China is “different” — consumers are far less dependent on debt for home purchases; they have many fewer options for investing abroad than we do, so real estate is also a popular investment asset; and, of course, the biggest reason of all — the world’s most populous country is only getting bigger and more urban, so housing demand should continue to increase. Xinyuan’s developments are a small part of that larger trend, and they do appear to be in better shape now than a few months back, but their share price still reflects worries about whether they’ll be able to grow profitably and increase sales in the quarters to come. As with other economies, the likelihood is that real estate development in China will probably remain quite cyclical, so if the economy keeps growing one might assume that we’d see the wind at XIN’s back.
Xinyuan doesn’t have much analyst coverage, but the one analyst on Yahoo Finance expects them to earn 31 cents a share in 2010, giving them a forward PE of about 14. Morningstar pegs their fair value at $6 a share, but claims great uncertainty about that valuation and suggests buying around $2.40. Robert Hsu, in my estimation, thinks they’ll continue to beat estimates and raise expectations, and that you need to own these shares before they report another good quarter (you’ve got a couple months to wait on that). Assuming that I’m right in my sleuthing here, which I’m pretty sure I am, Hsu wrote to his subscribers about this one last night, but, perhaps because he also touted it at higher prices, his readers do not seem to be particularly obsessed with buying the stock — the shares are pretty much flat this morning (though perhaps without his push they’d be down a few ticks, as EJ is today).
What do you think? Cheap for a reason, or an undiscovered bargain? Let us know your thoughts with a comment below.
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