Domain Hits The Boards Fully Valued

This story features DOMAIN HOLDINGS AUSTRALIA LIMITED, and other companies. For more info SHARE ANALYSIS: DHG

Newly listed Domain offers exposure to favourable trends in the Australian real estate listings market but brokers believe the stock is fully valued at the present time.

-Difficulties faced include competition and the prospect of a decline in print earnings
-Likely to need more JV arrangements with real estate agent customers
-Investment in adjacent products could provide another source of growth
 

By Eva Brocklehurst

Real estate services business Domain Holdings Australia ((DHG)) has commenced life as a listed entity, after being separated from news and information provider Fairfax Media ((FXJ)). Fairfax retains a 60% holding.

Real estate listing websites have become the primary marketplace for advertising real estate in Australia and have built valuable networks. Analysts at Morningstar point out value is monetised via growth in revenue per listing, largely at the expense of real estate agent fees.

The analysts note subscription and upgrade fees were not disclosed by Domain and do vary by location. The public currently pays $660 for the most basic property sale listing on Domain for eight weeks.

Domain offers exposure to favourable trends in the Australian market with relatively low exposure to real estate price risk and should benefit from the growth in Australia's population and similar growth for dwellings via more real estate listings on its websites. Morningstar expects an underlying growth rate for earnings per share of 18% over the next three years.

Goldman Sachs initiates coverage of the stock with a Neutral rating and a $3.30 target, believing that growth is priced in, given REA Group's ((REA)) market dominance and the risks to the Domain agent ownership model, as well as print earnings.

The broker still maintains a positive view on the operating outlook and acknowledges the business has successfully moved into a digital property ecosystem that competes effectively with REA Group.

The hybrid digital/print offering and domestic focus means the company can benefit from growth in the broader market and gain market share. The broker forecasts FY17-20 revenue growth of 11% per annum. Nevertheless, this does not reflect the difficulties from competition and the prospect of a decline in print earnings.

Citi agrees that, while the earnings trajectory is positive, current valuation is excessive. Domain's digital platform benefits from its high exposure to the Sydney and Melbourne markets, which will provide a short-lived volume boost versus its rival. This is considered unlikely to extend much beyond FY18. Domain is counter-cyclical to the property market and rapid sales were a significant headwind, particularly in FY17.

Citi expects listing volumes to rise as the property market cools and property takes longer to sell. In line with this observation, auction clearance rates have fallen, averaging 69% over the past four weeks versus 76% in FY17.

Citi assumes clearance rates decline to the long-term average of 60%, leading to a 12% increase in listing volumes by the end of FY19. The broker concedes there is scope for earnings upgrades if property turnover rates were to rise but this appears unlikely in the near-term. The broker initiates coverage with a Sell rating and $3.40 target.

Macquarie agrees the current valuation is challenging, but considers this to be the case for REA Group as well, initiating coverage on Domain with a Underperform rating and $3.40 target.

Domain Vs REA Group

Morningstar has a fair value estimate of $2.90 a share for Domain, which implies an equity value of $1.7bn, around one quarter the valuation of REA Group, which generates over four times the operating earnings of Domain.

To compete with REA Group's first-mover advantage and attract the number of listings required, Domain is likely to need joint venture agreements with many of its real estate agent customers. Further to this, Domain intends to buy 50% of Review Property, currently owned by agents.

Review Property generated $8m in operating earnings (EBITDA) in FY17 and the acquisition should therefore increase the earnings attributable to Domain by around $4m. Domain expects to pay around $36m in scrip for the stake.

Morningstar believes it likely that further agent groups will be acquired in the medium term. Print remains 22% of group revenue which comprises a range of real estate and lifestyle-theme magazines, distributed through Fairfax newspapers.

Adjacent Growth Sources

Despite Domain having higher medium-term growth prospects, Macquarie agrees this needs to be balanced against REA Group's greater scale, lower capitalised investment expenditure relative to earnings and the impact of Domain's agent ownership model. The broker suggests, however, that recent investment in adjacent products could provide another source of growth.

Macquarie attributes $92m in value to minority interests via the agent ownership model, offset by $90m ascribed to value creation from investment in adjacencies, such as home loans and referral/connection revenue across energy, telecoms and insurance markets.

Macquarie observes the company can capture yield via both price increases and a shift in mix, such as increased take-up of depth products. Price rises are likely to be greater in the more mature markets.

The broker does not believe the strong presence of REA Group in Sydney and Melbourne will inhibit growth for Domain. Canberra is different, as Domain is positioned as the dominant player following the Allhomes acquisition and REA Group is pricing more aggressively in that region to try and build its platform.

In markets where Domain is still looking to build share the company is expected to be more cautious regarding price increases and focus on depth penetration. Macquarie believes while the commercial real estate segment is an opportunity for Domain, which has a 15% market share by revenue, closing the gap will not be easy.
 

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