REA Group ((REA)) is expected to continue dominating Australian residential property market listings despite recording no revenue growth in the final quarter of FY19. Management is confident a recovery is on the way, amid increased buyer activity, lower interest rates and an easing of lending restrictions.
Ord Minnett agrees the worst of the property listings decline is likely in the past and REA Group should emerge relatively unscathed, upgrading to Hold from Lighten. The broker is still cautious about the stock, which is already trading at a significant premium to peers.
The positive aspect generated from the FY19 results centres on the company overcoming a significant downturn in listings volumes over the year to still post modest earnings growth. This stemmed from subscription price rises and increasing penetration of the Premiere All subscription packages. REA Group was forced to ease the terms of its Premiere All subscriptions to increase volumes but still believes subscriptions can expand without cannibalisation.
Industry advertising volumes remain negative, although Morgan Stanley points out leverage to a recovery will be significant. The first half of FY20 is off to a slow start, with listing volumes in July down -19%, including Sydney down -31% and Melbourne down -29%. Credit Suisse has feedback from agents which indicates that volumes for spring are likely to be down.
UBS expects revenue outcome in FY20 will be volatile. Listings are likely to decline in the first half and revenue will be heavily weighted to the second half. While delaying the timing of an assumed rebound in listings to the second half, Morgans asserts REA Group needs a rebound in listings volumes to avoid another downgrade to market expectations.
Yet Credit Suisse suggests REA Group can get away with a subdued outcome in listings because its key competitor is also exposed to the weakness and will need to cut back on marketing in particular.
Revenue grew 8.3% over FY19 with operating earnings (EBITDA) up 8.1%. No earnings guidance was provided. Listings weakness in the Australian market caused the results to underperform most expectations. Yet Asia was also affected by competitive pressures and the financial services business produced lower revenue because of tighter lending conditions as well as the subdued property market.
Morgans considers Asia a problem. Returns from the former iProperty business remain low, highlighting the intensity of competition in the region. The company has also reduced the carrying value of the Elara Technologies business, which operates three property portals in India. The broker suspects an injection of new capital in FY20 is inevitable.
Developer and commercial business has defied the cycle, Macquarie points out. Developer business has benefited from increased penetration longer duration of marketing campaigns and depth take up in commercial areas has been strong. There are opportunities in rental areas as REA Group is not monetising landlord-managed listings as yet.
Cost Freeze
Management has begun tightening its belt, freezing costs. Profit margins are expected to grow again in FY20, albeit modestly, and not be spread evenly over the year.
Macquarie finds this commitment to flat costs a key positive, delivering operating earnings leverage if volumes improve and protecting earnings if this does not eventuate. Barring a full-year decline in listings that outpaces the rate of price increases, Ord Minnett also believes the ability to pull on the cost lever is a major advantage.
Valuation
Morgans expects the company could deliver more years of double-digit earnings growth and achieve high levels of free cash generation with strong growth in dividends. Nevertheless, the broker’s share price target implies a negative total shareholder return and a Reduce rating is maintained.
The stock is trading broadly in line with historical multiples and, amid a lower bond rate environment, UBS assesses the valuation is fair. To the extent that listings growth is positive overall for FY20, the broker considers there is upside for revenue.
UBS is also impressed with the early agent lead conversions but suspects monetisation will be long dated. The company is expected to give away leads for free in FY20. Then, with leads priced at $150-200, subsequent revenue contributions should grow and become more material.
Three Buy ratings, three Hold and one Sell (Morgans) are on FNArena’s database. The consensus target is $95.65, suggesting -4.2% downside to the last share price targets range from $90 (Morgan Stanley, Ord Minnett) to $107 (Macquarie).
