REA Group Instils Confidence, Valuation Not So

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There is increased confidence in the outlook for REA Group after the first half result although the valuation is unsettling

-Price/depth levers may slowdown but listings growth should prevail
-Expanding revenue streams required to justify valuation multiples
-Tailwinds from low interest rates and home/lifestyle adjustments supportive
 

By Eva Brocklehurst

A resurgent housing market has helped REA Group ((REA)) exceed expectations in the first half and provided increased conviction among brokers about the outlook. While the current economic environment has negatively affected recent earnings, UBS envisages the company will recover strongly as long-term structural prospects are intact.

Morgan Stanley highlights the potential for a "super cycle" of earnings in 2021-22 amid a rebound in Sydney/Melbourne listings after the pandemic-fuelled lull, as well as additional volumes as Australians reassess working and living locations.

The results have shown, through a combination of yield and cost manipulation, REA Group was able to deliver earnings growth despite the restrictions stemming from the pandemic.

Still UBS suspects, going forward, traditional price and depth levers face a slowdown. Execution on other revenue streams such as leads, data monetisation and/or international is now required to maintain the growth profile and justify the valuation multiples.

On the subject of valuation, Morgans acknowledges its assessment generally signals a Reduce rating while the quality of the business and obvious momentum underscores the case for sticking with Hold.

REA Group provided no specific guidance, as is usually the case, but expects costs in FY21 to be in line with the prior year. Macquarie expects a "flat" outcome for volumes in the third quarter and a "materially positive" fourth quarter.

The price increase from July 1 2021 will also have an impact on earnings. The broker notes, while revenue was up 3% in the half year, the yield was negative, largely because of geographic mix and the limited contribution from Melbourne during the lockdown.

Still, listings growth of 4% was a firm outcome in light of limited transactions and, importantly, the positive listings outlook should prevail, Ord Minnett asserts, although marketing and travel costs will return.

Listings are forecast to grow 12.5% in the second half because of pent-up demand. The broker notes listings declined -2% in the first quarter but increased 10% in the second quarter.

Furthermore tailwinds from a low interest-rate environment, and home-lifestyle adjustments should be supportive. Morgan Stanley assesses REA Group needs second half operating earnings growth (EBITDA) of only 14% in order to achieve full year consensus estimates of $528m.

Products

The main surprise for Morgans was margins, with domestic margins increasing to 71.8%. The broker does not believe such margins are sustainable over the short term although should be well supported beyond FY22 as price increases flow through to the bottom line.

REA Group is considered well-placed to continue with high single-digit depth products price increases as consumers increasingly move online. Continued product development should also help the company's share of property transactions.

The market had expected an update on the outlook for monetisation of the Agent Match product, but Morgans points out REA Group is yet to consult with the industry.

Hence, little from this product is included in forecasts. The broker suspects Agent Match could be a material growth driver while assessing the group revenue result covers large moves in the developer market, which fared much better than expected, while Asia was weaker.

News Corp/International

A strong second quarter from News Corp was underpinned by cost reductions and REA Group, in which it is a 60.7% shareholder. For News Corp, operating momentum was strong at Dow Jones and book publishing experienced higher revenues.

Despite the sluggish news media segment, the New York Post recorded its first profit in "modern times", according to the company. The performance of Move, a US online real estate business (80% News Corp/20% REA Group) was a highlight, helped by higher referral and traditional lead revenue.

Morgans notes Move was well ahead of its expectations, with 20% revenue growth amid strong cost containment and Macquarie points out this was the first period of Move profitability since the companies acquired it in 2014.

REA Group Asia was weak, with continued pandemic-induced impacts from Malaysia. Much of the weakness in Asia was attributed to Malaysian restrictions and Morgans considers the outlook there is "relatively muted".

Having gained control of Elara in India, REA Group is set to improve its market position and the broker believes the size of the prize in India is worth the investment. REA Group now holds 59.65% of Elara with News Corp owning the remainder.

The Elara contribution will be fully consolidated from January 1, 2021. Macquarie also notes REA Group has plans afoot to acquire ownership of SRX, a data and analytics provider in Singapore.

FNArena's database has five Hold ratings for REA Group with one Buy (Morgan Stanley). The consensus target is $146.12, signalling -9.9% downside to the last share price. Targets range from $131 (Morgans) to $158 (Macquarie).

There are three Buy ratings and one Sell (Morgan Stanley) for News Corp. The consensus target is $27.52, flat versus the last share price.

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