REA Strength To Come From Depth

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

-Italian potential excites
-Strength captured in shares
-Depth revenue key to growth
-Decline in paying agents

By Eva Brocklehurst

Online advertising business, REA Group ((REA)), displayed strong half yearly earnings despite a subdued property market. While most brokers expect a continuation of this robust growth, it's the potential for capital management and acquisitions that provoke most interest.

The company specialises in real estate, owning the realestate.com.au site as well as international property sites in Luxembourg, Hong Kong and Italy. Management has stated it would like to own more business outside Australia, and Italy looks plumb for this. Certainly, the significant cash balance allows it, according to Deutsche Bank, noting the capital management outcome in the first half would've been different if M&A wasn't under consideration.

The significant potential of Italy has been welcomed by Credit Suisse and BA-Merrill Lynch. Credit Suisse thinks an acquisition which cements Italian portal Casa's position makes the most strategic sense, dependent of course on the price. BA-ML believes Italy offers the potential, with a recovery in Europe, to be 10% of the group's earnings in the next few years. UBS and Macquarie see the balance sheet strength providing both capital management and acquisition options.

However, many brokers believe this strength has already been captured in the share price. Deutsche certainly does, noting the stock is trading on 27 times its FY13 earnings forecast and 23 times FY14.With margins expected to remain firm and plenty of upside potential from Italy, BA-ML has raised its valuation and maintains its Buy call. Consensus earnings per share growth, revealed on the FNArena's Stock Analysis, is a forecast 22.4% for FY13 and 23.6% for FY14. There are five Hold recommendations and two Buys (BA-ML and Macquarie). Macquarie justifies its keenness for the stock with expectations of further strong growth and upside on the Italian front. The price target ranges from $19.68 (CIMB) to $24.50 (BA-ML).

The other aspect that interests brokers is, given the company's dominance of the online property sector, the potential to derive revenue from differentiating product pricing with depth, rather than just relying on annual subscription revenue. Credit Suisse notes this is where the strength in the results lies. The company increased its revenue potential with depth products such as Feature, Highlight and Premier listing products for residential clients, the Elite and Elite-plus products for commercial clients and the Project Profile product for developer clients. Residential revenue increased 21%, commercial revenue increased 25% and developer revenue increased 18%. Credit Suisse estimates the online real estate classifieds market in Australia is around $700-900 million and REA's superior product is likely to increase its pricing power and market share.

REA is already seen having around 70% of the online market. As such, the dominant player can also develop a direct-to-consumer product. JP Morgan notes this is designed to create a higher priced product and reduce the overall loss of advertising dollars in the move to online from print. The broker concedes the strategy, while contributing longer term to depth revenue, is not without risk. Real estate agents may not like it as it encroaches on their relationship with the vendor.

It all depends on how willing the agents are to de-couple advertising costs from the real estate selling costs, according to JP Morgan. The broker contends the agents are probably happy with the move to price on depth, rather than subscription only, as they find it hard to offload the cost of subscription pricing to the vendor. Depth pricing can also be more linked to market conditions. UBS also expects the company to capture greater yield upside as print classifieds migrate online.

There has been a decline in paying agents on the site in Australia. The company does not believe it's losing market share but rather that agent numbers are declining because of market forces. UBS thinks this is still a negative, noting total Australian paying agents fell 4% year on year. Deutsche also doesn't buy the company's explanation that the decline in paying agents stabilised in the second quarter. The broker believes the Queensland floods will impact the numbers in the second half. JP Morgan has observed that total listings grew 10% in 2012 and this inventory build suggests a sluggish market and vendors holding onto price expectations. 
 

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