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Treasure Chest: REA Undervalued

Treasure Chest | Mar 09 2017

This story features SEEK LIMITED, and other companies. For more info SHARE ANALYSIS: SEK

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. One broker suggests online real estate classifieds business REA Group is offering 25% upside in the next twelve months.

-Dominant market player
-Fastest growing classifieds business
-Domain listing a positive
-Discount to global peers

 

By Greg Peel

Back in the late nineties, it appeared the internet was set to take over all aspects of our lives, immediately. Any new dotcom was seen as a must-have, even though the bulk of the investor herd still really had no idea how this world wide web contraption worked. Home computers were few.

It all came crashing down in 2000, and while the Australian stock market had been sparse on online listings to begin with, investors were no doubt now wary of investing in this strange new world of meaningless PE multiples.

That did not stop three local companies deciding to take on the long entrenched “rivers of gold” business of newspaper classifieds. Around the turn of the century, Seek ((SEK)) began making a name for itself in online job ads, Carsales.com ((CAR)) in the new and used car market, and Realestate.com, later to become REA Group ((REA)), in the real estate market.

From little things, big things grow. It’s hard to believe just how far the world has moved towards digital reliance in such a short space of time. It certainly caught the newspapers and hard copy classified magazines napping – their tardiness in recognising the rapid shift allowed the three abovementioned companies to thrive.

Fairfax Media’s ((FXJ)) Domain real estate classifieds business had long dominated the Sydney and Melbourne markets, and having finally played catch-up in the digital space, Fairfax is looking to spin-off what is basically REA Group’s only local competition into a separate (albeit still majority owned) entity. Rupert Murdoch decided a while back it was better to join them then try to beat them, hence News Corp ((NWS)) is a major shareholder in REA Group.

The local results season just passed highlighted, yet again, that the only value in Fairfax is Domain and the only value in News Corp is its REA stake. Print is dead, and even News’ cable TV business is looking like an anachronism in the face of internet TV.

The problem for Domain is that REA got the jump. “We believe the market underappreciates the dominance of REA’s website,” suggested Goldman Sachs’ analysts in a note yesterday morning, “which continues to build its audience and add greater expertise and functionality”. Ironically, Goldman suggests the listing of the number two player in the market, Domain, will prove beneficial for REA.

Domain as a standalone business is undervalued by the market because it’s wrapped up in Fairfax and encumbered by the slow death of newspapers. Once spun-off, its true value will emerge. But this will only serve to highlight the value of REA Group, Goldman suggests, by providing a domestic comparable and “highlighting the positive underlying trends in the Australian digital real estate market”.

Real estate is the fastest growing online classifieds vertical in Australia, the analysts attest, implying a comparison with jobs and cars. REA boasts the dominant website domestically as well as being the number one player in Asia and the number two in the US. The performance of the Asian business in the first half disappointed stock analysts, but there was little disagreement the Australian business posted another solid result, particularly as cooling apartment listings provided a headwind.

Goldman Sachs believes the Australian online real estate market can grow 60% from FY16 to FY20 as the increasing sophistication of websites allows them to continue taking a share of an estimated $7.7bn spend on selling property each year. The analysts see a clear pathway for growth over the next five to ten years, and see significant scope for REA to leverage its dominant platform and increase its own market share.

One can only presume such a growth profile will encourage others into the market, and setting up a business in cyberspace is a lot cheaper than setting up in real space. Goldman Sachs acknowledges competitive risk, but believes barriers to entry continue to grow as REA builds its “virtuous circle of audience and inventory while improving the customer experience”.

REA’s share price peaked last August and retreated – not because the company did anything wrong, nor particularly because of warnings of the housing bubble bursting, but because the market simply switched into large cap miners and banks and out of previous high growth stocks. REA was not alone. The share price has since stabilised at a lower level, and received a bit of a kick when the company’s first half earnings result was well-received. But Goldman notes the stock is currently trading at a significant discount to its global real estate peers.

Goldman believes such price weakness presents an attractive buying opportunity. The broker has a Buy rating on the stock, forecasting a 14% compound annual growth rate in yield over FY16-20. A twelve-month target price of $68.50 implies 25% upside.

Goldman Sachs is not an FNArena database broker. The seven database brokers covering REA have a consensus target of $59.46. Six rate REA as a Buy or equivalent, with one Hold.

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CHARTS

CAR NWS REA SEK

For more info SHARE ANALYSIS: CAR - CAR GROUP LIMITED

For more info SHARE ANALYSIS: NWS - NEWS CORPORATION

For more info SHARE ANALYSIS: REA - REA GROUP LIMITED

For more info SHARE ANALYSIS: SEK - SEEK LIMITED