Has REA’s Upside Been Accounted For?

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

-High expectations in share price
-Outlook centres on agent conversion
-Depth listings need agent co-operation
 

By Eva Brocklehurst

REA Group ((REA)) garnered momentum in FY14 with the relentless migration of classified advertising online. The company's transition to listing/depth product revenue and away from subscription revenue for its real estate classifieds has driven earnings growth, with reduced fixed costs to agents. Will this continue? Most brokers agree the print component of real estate classifieds has fallen, and will continue to fall. This underpins the company's outlook but, given the stock is well priced, has all upside been accounted for?

Goldman Sachs believes the conclusion of the migration from print – which the broker forecasts will fall to 21% of real estate classifieds by FY17 – will test REA's business model, because of the competitive intensity and buyer concentration in the market. Moreover, REA's investments on the international front are unlikely to be a material driver of earnings at this stage. The broker retains a Neutral recommendation and downgrades future earnings growth forecasts. Goldman's target drops to $46.50 from $48.25.

Results may have beaten expectations but CIMB is not buying the long-term outlook. The broker believes the composition of the result leaves a lot to be desired. REA did not provide any FY15 guidance. CIMB remains concerned about agent resistance to the new market-based pricing, and agents are necessary to drive the company's depth strategy. The broker believes agents are worried they will be distanced from their commission pool and are looking at ways to reduce REA's dominance of the online market.

CIMB considers depth listings – where value is gleaned from more detailed advertising – benefit agents and REA more so than the vendor of the property, so it remains important that REA work with agents. The broker does not believe there is a case for a material change in the level of real estate advertising expenditure over the medium term. This is heightened if REA is not working with agents to grow advertising expenditure. A Reduce rating is retained. In CIMB's view, stocks priced for perfection must deliver and this means REA.

Credit Suisse takes the other tack, upgrading to Outperform from Neutral. The broker was surprised by the fall in the share price in response to the result and believes this has created a near-term buying opportunity. Strong growth is expected to continue in FY15. The broker believes REA still has significant opportunity to grow share of real estate transaction spending. Ongoing investment is likely to limit near-term margin improvement but Credit Suisse expects there is potential for margins to rise significantly, if the company decides to ease back on discretionary investment spending. Margin disappointment is probably the source of the market reaction, in Macquarie's opinion, as the conversion rate of incremental revenue to earnings is lower and reflects ongoing investment in product and promotions. Macquarie expects this level of spending to continue but also considers the share price is full and retains a Neutral rating.

UBS has also upgraded, to Buy from Neutral. The stock remains the broker's preferred play in the Australasian online segment. Upside to the broker's price target ($49) hinges on execution and the success of new products as well as delivering acquisition value beyond the recent acquisition of a stake in iProperty ((IPP)). The broker has lifted forecasts for FY15-18 by 4-8%, factoring in the market-based pricing and new product initiatives.

Earnings are the most relevant metric in the results for Deutsche Bank and, despite strong growth, the slight miss to FY14 forecasts shows just how high expectations have built. The share price reaction is probably overdone, in the broker's opinion. Management is reluctant to acknowledge that the stake in iProperty, and a sale of securities purchased on market that were sold at a profit, represents any change in strategy, but Deutsche Bank considers this signals a shift to a more acquisitive approach. The company also provided limited detail on the take up of its new model by real estate agents but the broker's checks suggest a reasonable number have made the transition. Deutsche Bank remains comfortable with forecasts for 45% growth in depth revenue in Australia and retains a Hold rating.

JP Morgan observes some protest regarding the changed pricing model, in that a small percentage of the agent market has combined to attempt to barter with REA on the matter. The broker understands the situation remains unresolved as REA is yet to engage. FY14 revenue was up 30% but the extent of cost growth meant a small miss at the earnings line for the broker. The economics of the industry remain favourable but, given trading multiples and new management, the JP Morgan prefers to retain a Neutral recommendation.

On FNArena's database there are three Buy ratings, three Hold and one Sell. The consensus target is $46.98, suggesting 6.2% upside to the last share price, and compares with $46.34 ahead of the results.
 

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