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REA Growth Robust Despite Weak Backdrop

Australia | Aug 14 2017

This story features REA GROUP LIMITED. For more info SHARE ANALYSIS: REA

The outlook for REA Group remains robust, although several brokers suggest expectations had become inflated.

-Double-digit earnings growth still expected in FY18
-Price rises and increase in depth volumes should counter softer residential outlook
-Losses at iProperty and Prop Tiger expected to detract only modestly

 

By Eva Brocklehurst

REA Group ((REA)) has grown its premium advertising volumes and counteracted weakness in expenditure by developers. Nevertheless, FY17 results fell short of many expectations, which several brokers believe had become inflated. A better Australian result was matched by lower Asian earnings and slightly higher costs. Operating earnings (EBITDA) at $380.9m were up 16.2% and net profit at $228.3m up 11.7%.

While the headline fell short of forecasts, underlying growth of 12% is still acceptable and, therefore, Morgans believes another year of double digit earnings growth can be banked. FY18 has kicked off with rising volumes in depth advertising, a price rise and more Premiere All subscribers.

Investors are being offered exposure to the growth in online real estate advertising in Australia, South Asia and US and the broker expects the company to deliver high levels of free cash, enabling strong growth in the dividend. As the stock trades well below the revised valuation, Morgans upgrades to Add from Hold.

UBS also upgrades, to Neutral from Sell, suggesting the company should be applauded for delivering growth against a backdrop of depressed residential listings. With the stock re-rating to nearly $70 amid little news, the broker suggests the market appeared to be pricing in a beat to earnings or the outlook.

UBS calculates that consensus estimates probably factored in operating earnings of around $470m but the company would need to deliver more than 24% growth in FY18 revenue on this basis, and this is unlikely.

The broker forecasts FY18 group revenue and operating expenditure growth of around 20% and 21% respectively.  This implies FY18 operating earnings of $455m. UBS believes the long-term trajectory is intact and the next catalyst is the potential for a strong first quarter headline. The longer term upside exists from new products.

Macquarie was surprised by the implication that margins will contract FY18. The broker believes Asia is accretive to margins in FY18, given the low earnings base and there is robust growth for Australian business which should boost margins overall, adjusting earnings to account for a 70% domestic incremental margin.

Depreciation costs are rising faster than the broker had modelled and this compounds a slightly weaker earnings outlook. Macquarie continues to believe the valuation is challenging and makes no changes to its Neutral stance.

Morgan Stanley expects the market to take a more conservative view on the FY18 outlook yet, while this may put pressure on the shares in the near term, does not find anything to alter a positive fundamental view. Citi agrees, expecting an acceleration of Australian business will more than offset a subdued international outlook and declining Australia developer advertising.

Citi forecasts a residential revenue growth rate of 31% in FY18 and price growth of 15%. Residential is expected to contribute over 70% of the Australian revenue in FY18.

Credit Suisse upgrades to Outperform from Neutral, believing the stock is not expensive given its growth profile and the recent re-rating of peers. Ord Minnett, on the other hand, is more cautious, preferring few consecutive months of improvement before believing an inflection point is at hand. The broker is also unsure how much room there is for further annual double-digit price increases in a softer market.

Listings Mix

Macquarie notes, critically, the result was achieved against softening residential listing volumes and growth came from increased depth product and price increases. Depth revenues grew 18% to $482m because of a mixture of price rises and a growing share of premium ads in the total. The company re-opened its Premiere All subscription package late in FY17 and has instituted a 10-15% price rise from July so a similar trajectory is expected in FY18.

Developer and commercial revenues grew 15% over FY17 but Morgans noticed the second half was weaker because of a slowing of new dwelling commencements. The company acknowledges growth in the developer display category will be difficult in FY18.

Deutsche Bank finds the commentary about costs was reminiscent guidance provided 12 months ago, where management guided to negative jaws, where expenses exceed income growth, after the inclusion of an acquired business.

Residential depth revenue growth of 25% is expected to be driven by a combination of pricing, volume and shift in the mix. Deutsche Bank expects this could be offset by lower developer volumes, forecasting total depth revenues to grow by just under 20%.

Asia

Asia remains weak and the recently acquired iProperty business lost money in the second half because of the slump in new projects in both Malaysia and Hong Kong. Macquarie observes weak cyclical trends are being countered by a step-up in investment in product and marketing. Meanwhile, Move Inc in the US is progressing, with revenues up 10% to US$394m in the year. The business has just passed the point of breaking even and should generate modest profit in coming years.

Citi cuts estimates for earnings per share by -4% for FY18-20 to reflect the poor performance of iProperty Asia and continued reinvestment into Prop Tiger (India). Nevertheless, this is still only expected to detract slightly from strong growth of the core Australian business. Changes to Deutsche Bank's estimates primarily result from an increase to the losses expected at iProperty and Prop Tiger, expected to reverse over time.

There are four Buy ratings on FNArena's database and four Hold. The consensus target is $69.43, suggesting 5.0% upside to the last share price. This compares with $67.40 ahead of the results. Targets range from $64.00 to $80.00.
 

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