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Domain’s Warning Douses Outlook For Media

Australia | Oct 15 2018

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

Domain has issued a sharp downgrade to its outlook as the gloss comes off the housing advertising market, and other media players are caught up in the trend.

-Extent of Domain's downgrade to guidance a surprise to most brokers
-Drop in premium Sydney and Melbourne markets the main cause
-Fall in Nine Entertainment, Fairfax stocks likely an overreaction

 

By Eva Brocklehurst

The shine has come off the top end of the housing market, affecting the lucrative display advertising that spreads glamorous homes online and across the nation's magazines.

Domain is significantly affected because of its skew to the high-priced Sydney market but REA Group ((REA)) is not immune. Caught up in the downdraft, despite more diversified media markets, is Nine Entertainment ((NEC)) because of the planned merger with Fairfax Media ((FXJ)), which has a majority stake in Domain. All stocks have felt the heat in recent days.

UBS suspects the market was well aware of the potential for a soft trading update from Domain because of an "ominous" lack of guidance at the FY18 result. Still, the extent of the downgrade was a surprise. The broker acknowledges underestimating how the soft housing environment amplifies the impact on print bundling and revenue and high-value residential transactions.

While cost growth was also lowered this only provides a partial offset. The broker reduces Domain earnings (EBITDA) estimates for FY19 by -15%. Citi reduces earnings forecast by -4-8% across FY19-20 to account for the update to trading for both Domain and Fairfax. The majority of the downgrade relates to Domain.

A drop in premium (depth) advertising volumes in Melbourne and Sydney has caused Domain to warn of a rapid slowdown in the rate of revenue growth. Digital revenue has grown just 6% in the first 15 weeks of FY19 versus 19.9% growth in FY18. Sydney's new listings in the September quarter were down -8%.

As Sydney is the biggest driver of revenue, the impact is higher for Domain than for the market in general. The declines are significantly worse in inner city areas where there is a stronger penetration of depth products.

Morgans calculates Sydney accounts for around 44% of premium depth revenue and a slightly larger share of profit. The company expects media, developer and commercial revenues to be down on the prior year. Morgans believes, while there may be several years of growth ahead, the stock is overpriced and maintains a Reduce rating.

Digital revenue growth was much weaker than Ord Minnett forecast because of a drop in auction listings, a restructuring of the digital media business and weaker developer revenue.

Nevertheless, with depth penetration growing in every state, the broker remains a buyer of the stock at current levels and has an Accumulate rating. However, management has also decided to introduce a price freeze in Victoria in 2019 that Ord Minnett expects will put pressure on second half revenue growth.

On the other hand Credit Suisse makes changes to earnings forecasts which reflect an expected improvement in the second half and assumes some of the cost growth will be shifted to FY20, maintaining a Neutral rating.

Volumes may recover once the federal election is out of the way, although Citi suggests it is unlikely in the longer term that Domain will catch REA Group without a significant, disruptive shift in revenue share between the two.

REA Group

As a precautionary measure Morgans also lowers forecasts for REA Group. REA Group is, in its favour, less reliant on Sydney and Melbourne and does not share Domain's exposure to print. The broker believes current listing volumes are unsustainably low, yet the timing of any return to normal volumes is difficult to predict.

The risks to REA Group's earnings include steep falls in Australian residential listings because of a fall in paid depth volumes and a failure of new products to find widespread acceptance. There is also the risk of a deterioration in the operating performance of the company's Asian and US operations. Macquarie agrees the weak volumes will have a negative, albeit much more modest, impact on REA Group.

Fairfax/Nine Entertainment

Fairfax and Nine Entertainment also provided trading updates ahead of the scheme merger booklet. The latter's update was largely in line with estimates, confirming existing earnings guidance of $280-300m. UBS suggests the drop in the share price of both stocks relative to Domain signals an overreaction.

While the market cap of Domain dropped -13%, in turn, the post-merger NEC/FXJ entity will only have around a 59% exposure to this valuation decline. Yet their respective market caps fell around  -12-13%. Logically, UBS points out, the difference could be from the market attributing a lower valuation to TV but… there was no TV downgrade. UBS upgrades Fairfax to Buy from Neutral.

As a result of the drop in the Nine Entertainment share price, Citi believes the premium for Fairfax shareholders has been eliminated. Based on the current share price of Nine Entertainment the offer values Fairfax at $0.69 a share, below the broker's fundamental valuation.

Hence, the benefit to shareholders voting in favour of the merger is less obvious and the broker is no longer confident it will proceed under current terms. Citi now reverts to valuing Fairfax on a fundamental basis rather than an implied takeover price. A Neutral rating is maintained.

Macquarie forecasts lower operating earnings in FY19 and FY20 for Fairfax, partially offset by higher radio estimates. Financial year-to-date revenue is down -5%. The broker notes metro media is flat, implying a slight moderation in growth, while regional media revenue is down -10%. Radio provides the positive offset and Macquarie lifts FY19 growth forecasts to 3%.

Domain has two Buy ratings, two Hold and two Sell on FNArena's database. The consensus target is $3.11, signalling 15.7% upside to the last share price. Fairfax has a consensus target of 84.3c, signalling 23.9% upside. There are two Buy ratings and two Hold.

There are two Buy ratings, one Hold and one Sell for Nine Entertainment with a consensus target of $2.19, suggesting 17.0% upside. REA Group has three Buy, two Hold and two Sell ratings. The consensus target is $89.50, suggesting 22.1% upside to the last share price.

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