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REA Group Outlook Strong Despite Headwinds

Australia | Feb 12 2018

This story features REA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: REA

A more modest growth story is likely from REA Group in the second half yet brokers expect the company to maintain its dominance and still produce strong listings volumes.

-Several factors may dampen earnings growth in the third quarter
-Yet considerable upside is envisaged for Australian depth products
-Financial services & agent comparison may drive a step change in earnings in the medium term

 

By Eva Brocklehurst

REA Group ((REA)) has provided a consistent and robust first half and, while management suggests more moderate growth is probable in the second half, brokers suspect there is potential to surprise on the upside.

Seasonally, revenues are expected to be lower anyway but there are reduced project start-ups which will affect developer revenue. The company has also pointed to a early start to Easter, which will impact earnings growth in the third quarter.

Guidance for the remainder of FY18 appears relatively subdued but remains consistent with Deutsche Bank's forecast for a slowdown in volumes. The broker suspects the company is trying to hose down expectations after a strong first half.

Industry data signals listing volumes were down in January but this is generally a slow time of year so Deutsche Bank does not place much weight on the numbers.

Autumn remains key to the performance of real estate classifieds. Hence, while a deceleration is likely, the broker does not ultimately believe volumes will become a headwind. The broker also believes pointing out specific issues, such as Easter, is merely conditioning the market to the lumpiness that is inherent in quarterly reporting.

Deutsche Bank expects Premiere listings to grow but does not expect the same level of growth, given Sydney and Melbourne are unlikely to provide as much impetus. UBS adds that, as Sydney and Melbourne are the most profitable markets, volumes, depth prices and depth penetration are higher than the rest of the country.

This means the outperformance of the two main cities drives higher rates of revenue growth than would have otherwise been achieved if growth was evenly shared nationally. The broker remains comfortable with FY19 forecasts and factors in similar nominal revenue growth in Australia versus historical trends.

Morgans calculates that the rush to sell upmarket existing properties delivered a $52m bonus in the first half, which overcame weakness in the new apartment, market and suggests that while the company is being cautious in its outlook, the second half is not likely to disappoint.

Citi reduces estimates by -4-5% over FY18-20, factoring in a rapid decline in developer revenues and flat residential listing volumes the medium term. Growth is expected from price increases and depth take-up. The broker estimates revenue growth will drop to the mid teens and operating earnings (EBITDA) growth to the low teens in the third quarter.

However, this is mostly a timing issue and the broker envisages 19% growth in operating earnings for FY18. The broker expects growth rates in the core business will slow as, overall, national volumes have remained flat in the first half and there are few signs of an increase in the number of properties listed for sale.

Depth Products

Shaw and Partners envisages continued upside in Australian depth products and suggests the value addition of Premiere listings is pushing agents to lock in discounted rates, as opposed to one-off listings, by taking out all-in contracts.

High renewal rates for depth products, as well as increasing take up, imply sound foundations are being set for future yield leverage and Shaw and Partners, not one of the eight stockbrokers monitored daily on the FNArena database, has upgraded to Buy.

The multiple may be demanding but the broker still it believes there is further double-digit growth that can be extracted. Cyclical factors remain a material risk as well as general volatility. REA Group is also expected to maintain its dominance of the online real estate market. The broker sets a target of $80.18.

New Products

The new products the company has launched may be meaningful in the longer term and Citi believes it is financial services and agent comparisons that have the potential to drive a step-change in the earnings profile.

Smartline Home Loans is now contributing to earnings but the company is yet to start charging for agent comparison, and the broker suggests that neither the company nor its competitor Domain ((DHG)) have identified the best model to take this product forward.

The joint venture with National Australia Bank ((NAB)), Morgans notes, will not be fully up and running until late February.

Macquarie observes media display revenue, particularly developer revenue, has been negatively affected by the decline in both dwelling commencements and the total media market. Valuations have now come back to more attractive levels, to some extent, and the broker upgrades to Neutral from Underperform.

To turn more positive, Macquarie would want to witness upside from the upcoming price review as well as the delivery of growth from new products.

The broker notes some of the smaller, or more peripheral, parts of the business face challenges, such as media, where revenue growth has been modest, and developer, where revenue declined.

Asia delivered some top-line growth despite headwinds in Malaysia and Hong Kong. Malaysia could be affected by the upcoming election in the near term. Macquarie expects ongoing reinvestment in Asia to subdue returns over the next few years.

Ord Minnett notes management appears unconcerned by the decline in listings in January and into February, because of seasonally low volumes and view that a more moderate real estate pricing environment is more conducive to listings growth.

The broker is confident that robust conditions and growth will continue but would like the listings decline to ease in coming months before becoming more positive in its investment view.

The database shows one Buy (Morgan Stanley) rating, six Hold and one Sell (UBS). The consensus target is $75.39, suggesting 0.5% upside to the last share price. Targets range from $67.30 (Deutsche Bank) to $85.00 (Morgan Stanley).

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