Depth Products Deliver Strong Outlook For REA

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Brokers retain a positive outlook for REA Group's core online real estate classifieds in Australia and believe the offshore business will take a little time.

-Growth in depth listings should maintain revenue growth despite falling volumes
-Tougher macro background in Asian developer business along with ongoing investment
-Softer market for large apartment block developments
 

By Eva Brocklehurst

Online real estate business REA Group ((REA)) scored a solid first half result on broker cards, underpinned by its core Australian business. Momentum is expected to pick up in the second half.

Australian revenue was up 11.8%, despite lower listing volumes nationally. Listing depth revenues grew 16%, from price increases that were effective from July.

After adjusting for the divestments of Europe and inclusion of North American associate losses, net profit was below Credit Suisse forecasts. Normalised net profit growth of 5.6% was affected by the dilution from the iProperty acquisition.

The broker does not forecast a major bounce in listings but does expect volume headwinds will ease in the second half. Credit Suisse remains positive on the medium to longer term online property opportunity, driven by price rises and depth penetration.

The main disappointment for brokers was the performance of Asian assets because of a tougher macro background, strong competitive activity and ongoing investment in the business.

Yield Growth

Macquarie expects revenue growth to pick up modestly in the second half. Against this cost growth should moderate. The broker envisages scope for operational earnings (EBITDA) growth to exceed 20% and margins to expand across the year.

Citi also expects continued yield growth in depth listings, which should maintain mid-teens revenue growth in Australia despite volumes falling. The broker notes the company has three yield levers to pull including price, mix and rising penetration rates. Earnings are currently subdued because of low cyclical advertising volumes but there is scope for significant upgrades if the market recovers.

Morgan Stanley is also happy with the first half results in the core Australian business. Moreover, the broker notes listings in January have apparently turned to positive although it is too early to call a recovery. Asian numbers also disappointed Morgan Stanley and the broker expects scrutiny on capital allocation in this region to intensify.

Deutsche Bank concurs that January suggests some growth may be returning to listings and believes the next couple of months will be critical in order to gauge underlying trends. The broker currently expects flat volumes in the second half.

Pricing and the introduction of new products are expected to be key drivers in the shift to depth products and Deutsche Bank expects price increases of 7.5 % will be put in place at the start of FY18.

Asia/US In Slow Lane

Morgans believes the results are stronger than they appear on the surface. This reflects the power of the company's franchise with consumers and real estate agents. The broker acknowledges parts of the business are weak, such as developer display ads and Asia, but these are all dwarfed by the Australian residential strength.

Developer advertising spending was weak because the market for the launch of large apartment blocks has cooled . The company acknowledges the weakness will continue as a glut in apartments unfolds. This affects Asia, with a dearth of new apartment launches in both Hong Kong and Kuala Lumpur.

Morgans observes Asia is stuck in the slow lane but the upside in this is that REA will pay less to buy out the minorities in iProperty next year. The company has booked a $10m gain on deferred consideration.

The main risks to the company's outlook are further steep falls in Australian residential listing volumes, which cause a commensurate fall in depth listings, and the failure of new product initiatives to gain widespread acceptance.

Almost all of Morgans valuation stems from the Australian business, where an opportunity is envisaged for 4-5 more years of strong growth. Should the Asian and/or the US business provide substantial earnings growth over time, the broker acknowledges its current valuation would be too conservative. Still, it remains too early to make a judgement call on offshore business.

The main risk in UBS estimates is with the listing volume outcomes in FY17. That said, the outlook appears brighter to the broker given that both Premiere I and II agents both roll off existing discounts on June 2017. UBS also remains wary of slowing developer growth.

FNArena's database shows six Buy ratings and one Hold (Deutsche Bank). The consensus target is $59.25, suggesting 10.8% upside to the last share price. Targets range from $51 (Deutsche Bank) to $65 (Morgan Stanley).
 

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