Sold! REA comes through with growth
When REA Group (ASX:REA) announced the FY17 full year results the shares fell six percent (they’ve since recovered). REA Group reported an underlying profit for the full-year FY17 of A$228.3 million, which was up about 12 percent. Most of the growth can be attributed to growth in the more expensive ‘premium’ depth ads, and much of the growth came from higher prices.
Our thesis has been that of the more than $7 billion spent on marketing residential real estate in Australia, an undeserving 83 percent goes to real estate agents. Less than 10 percent of the total spend goes to REA and we believe the company brings more than 10 percent of the value to a real estate transaction.
In the shorter term we believe that a maturing or flat property market would bring;
1) More vendors listing.
2) Lower auction clearance rates and therefore longer times ‘on market’, which in turn means more listings at any one time.
3) More aggressive competition among vendors who will pay to highlight or feature their property and therefore a higher average ARPU. Combined, a mature property market delivers more growth for REA.
Here are some important insights from the REA Group result that adds to the thesis.
Total listings in Australia have declined 21 percent since 2011 (in this environment REA Group has grown revenue by 20 percent per annum). In the most recent year however REA noted total listing volumes have begun to “stabilise”.
A mix shift in favour of more expensive Premiere ads saw Australian listings depth revenue grow 18 percent over the year and more than 21 percent in the second half.
The company noted that margins in its core business would expand in 2018 however overall group EBITDA margin would narrow during FY18 due to the incorporation of the new finance business.
The share of Premiere ads continues to increase as a share of all ads on REA.
REA noted developer and commercial revenues, which grew 15 percent over the full year, although declined meaningfully in the second half.
The iProperty business, which was purchased for more than $700 million lost money in the second half thanks to weak markets in Malaysia and Hong Kong. The vendors of iProperty have moved on to building and growing iFlix in Asia – a competitor to Netflix offering local content. Future buyers beware!
More recently, there were 80,824 depth listings counted on realestate.com.au for the week ending 11 August 2017, which represented an increase of 4,930 listings (6.5 percent) on the same week a year ago.
According to our friend Ivor Ries over at Morgans, over the past six weeks the two most expensive categories of depth listings were on average 14.9 percent higher than a year ago and more expensive Premiere listings totalled 28,372, 27.8 percent higher than the same week last year. Ivor concluded; “Revenue growth from price rises is offsetting slower growth in volumes.”
Depending on our assumptions for further ‘depth ad’ price rises in the future, Montgomery has estimates for a valuation of REA Group up to $80 per share.
The Montgomery Funds and Montgomery Global Funds own shares in REA.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Jeremy
:
I just can’t get my head around an essentially Australia-only single-sector classifieds site being valued at ~$9bn. The metrics look great, don’t get me wrong, but stepping back that number doesn’t make a whole lot of sense. For $9bn I could own 60% of Ramsay Health, which has an almost impermeable quasi-monopoly on Aussie hospitals, a strong global business, and may well be the best run hospital company in the world. 60% of a dominant hospital group, with enormous barriers to entry and great macro, or a classifieds portal that has only come into relevance in the last decade (replacing print classifieds), and may well be replaced by something new over the next two decades?
Roger Montgomery
:
Good counter points Jeremy.
Max Zan
:
I agree with you Roger that REA is a great business, but does the current market price of about $68.00 represent good value ? Based on some simple arithmetic I’m not convinced it is.
The 2017 Financial Report reveals the following
– Equity per share 30/6/17 $6.11
– Mormalised Earnings per share $1.73
– ROE 30% (based on average Equity per share $5.77)
If REA group was a no growth company and your required rate of return was 10% then it follows that a fair share price would be $18.33 ( 3 times Equity per share $6.11)
The current share price is around $68.00, so you can conclude that about $50.00 ( the difference between $68.00 and $18.33) of the share price represents the PRESENT VALUE OF FUTURE GROWTH. Based on last years earnings per share of $1.73 it would take about 29 years to make up that $50 – and that’s not taking into account the return on the $18.00. Taking into account the time value of money and a required rate of return of 10% the $50.00 has to return your $5 per share at ” TODAYS VALUE” for the next 29 YEARS – that’s a big ask. How can anyone be sure that will be achieved over such a long period ? Great Business but current share price comes with high risk and requires current high PE valuation to be maintained. That may happen over the short term, but as the Business matures and more earnings are paid out as dividends then it’s no long a high growth business and is valued accordingly. Future Goodwill impairements are also a real possibility.
Roger Montgomery
:
Thanks for sharing the counter view