Is Valuation The Issue Now For REA Group?

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Despite some looming headwinds, REA Group is reflecting a strong Australian real estate market and the main issue for brokers is the valuation

-Integration of Mortgage Choice and REA India going well
-Depth penetration and add-on products key to the outlook in FY22
-Is valuation support for REA waning?
 

By Eva Brocklehurst

Australia's real estate industry remains resilient and REA Group ((REA)) has been a beneficiary. The company is also deriving a benefit from its financial services division, having recently incorporated the Mortgage Choice brand, as well as REA India (formerly Elara).

Ord Minnett observes the quarterly update had a conservative tone as the company remains mindful of a number of potential headwinds. These include potential regulatory action to address surging house prices as well as the impact of the federal election in the fourth quarter of FY22.

While cautious on valuation, the broker would not be surprised if management upgrades the outlook when operating conditions become clearer after Sydney and Melbourne emerge from lockdowns.

Morgans highlights the strong revenue growth for Mortgage Choice under REA Group's leadership along with an increase in broker numbers, which the former entity was struggling to obtain. REA will incorporate the SmartLine brand into Mortgage Choice and a full integration is expected in around 18 months.

The quarterly result was underpinned by residential listings and the impact of price rises in July. Depth uptake was also better than expected. Listings grew 11% in the first quarter while prices were 8% higher. Cost growth is expected to be in the high single digits, yet Credit Suisse believes this will be more than offset by higher revenue.

Higher depth penetration is key along with add-on products. The company did not provide specific growth rates for each of its divisions but indicted depth growth for residential was well above 20% in the first quarter.

The Premiere product had record take up in the first quarter and, with additional products such as Connect and Ignite, Morgans finds growth has been impressive. Given debt facilities are been refinanced and gearing remains low the broker would not be surprised if further acquisitions were made, either domestically or internationally.

Valuation

Morgans continues to believe REA is one-off the highest quality businesses on the ASX with its dominant market position and enhanced ability to broaden its reach. On the downside, there were some slight reductions to developer revenue and lower associate earnings during the quarter.

Furthermore, the broker considers some of the current strength is simply the pulling forward of listings, which means longer-term upgrades are likely to be more muted.

Despite a positive outlook, Morgans retains a Hold rating on valuation and would look to accumulate the stock below its target ($165.70). Macquarie's view, too, is unchanged, believing the shift to more value products and depth penetration is now factored into expectations.

As a result, valuation support is believed to be waning. The broker retains an Outperform rating and has become slightly more positive about the outlook for listings, although the looming federal election may prove a dampener.

Indeed, management has signalled volume comparables will become tougher in the second half and that the timing of the federal election may also have an impact. Still, Credit Suisse expects listings will be strong in the second quarter at the very least, because of the re-opening of Sydney and Melbourne.

Morgan Stanley also believes the first quarter result supports its investment thesis, and hails a potential "super cycle" for REA earnings over FY22-23. This should stem from the rebound in Sydney and Melbourne listings, higher churn as Australians review work/living priorities as well as price increases and margin expansion.

While the company provided no explicit guidance, the broker anticipates, since operating earnings (EBITDA) grew 28% in the first quarter, that growth over the rest of the financial year of 11% is required to achieve full year consolidated EBITDA of $645m.

Combining higher yield growth and domestic expenditure assumptions, Goldman Sachs, raises FY22-24 EBITDA estimates by 1-5%. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $193 target.

Ord Minnett asserts, on a range of metrics REA trades at a premium to competitor Domain Group (((DHG)) which is wholly justified. The business differs in terms of operating metrics and characteristics such as margins, operating cash conversion and free cash flow. Still, the broker retains a Hold rating on valuation grounds.

FNArena's database has two Buy ratings and four Hold. The consensus target is $169.03, suggesting -4.4% downside to the last share price. Targets range from $145 (Ord Minnett) to $192 (Macquarie).

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