REA Group: A Tale Of Two Cities

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As house price rises in Sydney and Melbourne begin to wane, can REA Group’s solid momentum continue through FY25?

-REA Group posted a largely in-line FY24
-Sydney/Melbourne listings the key FY25 swing factor
-Opex guidance lower, but capex and D&A higher
-Buy ratings dominate

By Greg Peel

It has surprised most that in the face of thirteen RBA rate hikes to fight inflation since May 2022, and the cost of living crisis that inflation has wrought, Australian average house prices have continued to March ever higher.

In the early stages, price rises were driven by the two biggest cities of Sydney and Melbourne, but recent data show the pace of growth in both has slowed more so in Melbourne as other cities have taken the baton. A lack of affordability has sparked an exodus to large towns, such as Adelaide and Perth.

As market leader in property classifieds, REA Group ((REA)), wrapped up a solid FY24 with a strong June quarter performance, the question of the trajectory of property listings into FY25 has become the big issue for analysts. The result was largely in line with forecasts but “Market listing volumes are difficult to predict with accuracy,” says Jarden, “and they are set to be the key swing factor to FY25’s outcome”.

REA’s revenue growth of 24% year on year for Australian residential, and 31% for REA India, were the standouts among the company’s FY24 financial results. Australian residential property listings grew by 7% over the year. The crux is that included 21% in Sydney and 22% in Melbourne.

Management is guiding to flat listing growth in FY25. Analysts note REA is typically conservative in its guidance, but management has specifically called out Sydney/Melbourne uncertainty as the driver of conservatism. Analysts are mostly a little more positive, but see management’s point. The two biggest cities offer the highest yield.

Headwinds

In recent months it has become apparent Sydney and Melbourne may have reached a peak of affordability, keeping buyers at bay or, as noted, driving them to look elsewhere. Earlier in 2024, an easing of growth in inflation had economists forecasting the first RBA rate cut as early as this month.

Well, that bird’s flown.

Rate cut expectations soon began to be shifted out to early 2025. Most recently, and despite as good as a promise from the Fed to start cutting in September, the RBA has remained doggedly hawkish. Australian inflation is no longer playing ball, and “higher for longer” expectations have been rekindled.

The RBA has warned yet another rate hike is not totally out of the question.

If home buyers and investors were happy to pay up on the expectation rate cuts were just around the corner, they must now be rather disappointed.

Another issue for REA listings is the next federal election, due by May next year. The uncertainty of election outcomes tends to lead to a quietening of real estate activity until the winner, and subsequent policies, are known.

Nevertheless, investor selling activity in Victoria is continuing given recent land tax changes and tenancy protection laws. REA’s July listings saw Melbourne volumes rise 15% versus Sydney’s 12%, despite house prices moderating faster in Melbourne.

Costs

REA achieved 19% buy yield growth in FY24, in line with guidance, driven by an average 13% contracted price rise for FY24 on top of the year-on-year growth in depth penetration and a 3% positive geographical mix impact from the strong Sydney/Melbourne listings for the year.

Looking to FY25 guidance, operating expenditure is forecast to be in the high single digits, which is better than the low double-digits analysts had been expecting. Lower opex is reflective of management’s more conservative expectations around Sydney and Melbourne listings.

On the flipside, capital expenditure guidance is higher than expected as REA looks to ongoing investment in operations and products. Depreciation & amortisation is also much higher than forecast, given REA’s significant investments since FY22.

Combining opex and capex guidance, Macquarie calculates total costs will be up 11% in FY25, including a 20% lift in capex.

Some Mixed Views

Despite uncertainty over the two big markets, Macquarie suggests if the current pace of listings continues through 2024, including the usual bump up in spring activity, listings could be up by 2% in FY25.

The broker notes the September and December quarters of FY25 will be cycling easier comparables to FY24 but March and June will be tougher.

The fundamental outlook in the next 6-12 months should remain solid, Macquarie believes, underpinning incremental earnings upgrades. Valuation support is limited but relative valuation among digital marketplaces is starting to look supportive for REA.

Macquarie retains Outperform, lifting its target to $219 from $210 to take account of a greater contribution from REA India.

REA continues to entrench its market leadership position, notes Bell Potter, through a “virtuous cycle” of free cash flow generation and platform reinvestment, which is returning in excess of 30% on invested capital. Management has flagged a return to top end of its 7-9% targeted range for capex to revenue, signalling positive expectations of underlying operating conditions during FY25 at this stage.

Bell Potter retains Buy, lifting its target to $223 from $218 after increasing its FY25 earnings forecast and its applied PE multiple.

UBS continues to maintain a view of slightly higher volume growth into FY25, despite the company reiterating its base case of flat growth. UBS has trimmed slightly its residential yield growth forecast for FY25 to 14% from 15%.

The key components of forecast yield growth include a price increase of 11%, depth penetration growth of 3%, and a geographical mix drag of -1%. The biggest risk to the yield forecast for FY25 is geographical mix, UBS warns, assuming Sydney/Melbourne’s strong growth starts to moderate relative to the rest of the capital cities.

On Proptrack data, the listings growth difference between Sydney/Melbourne and the rest of the capital cities had begun to moderate in the June quarter to 18%, UBS notes, compared to 20% in the March quarter, with the month of June narrowing to 9%. The broker warns downside risk to geographical mix could be as much as -5% should Sydney/Melbourne start to slow faster than expected.

In this scenario, UBS would expect REA to pull back on discretionary costs to manage “jaws”.

Brokers are pleased REA has guided to ongoing positive “jaws” — the difference between the growth rate of operating income and the growth rate of operating expenses.

UBS retains a Buy rating but has ticked down its target to $232.20 from $233.60.

Citi believes REA’s 7% share price increase post result was overdone when considering uncertainty on geographical mix in FY25, which was offset by lower cost guidance. But Citi reiterates its Buy call, increasing its target by 4% to $230, expecting REA to deliver double-digit growth in its core residential business as it continues to evolve and get closer to the transaction by leveraging data and through new products.

Morgan Stanley’s Overweight thesis remains, and target of $220, based on FY25 being another double-digit year for compounding price increases and yield. History also suggests owning REA shares leading up to an RBA rate cut cycle is beneficial, notes this broker.

REA remains one of the highest quality franchises in its coverage, says Morgans, and while the medium term may exhibit some volatility, particularly around new listings volumes, Morgans believes management has levers to potentially pull in such an environment that should help offset this to a degree.

This broker’s price target of $197 has it retaining a Hold recommendation on the stock, but Morgans also acknowledges the strong market position and growth opportunities for the company (both domestic and offshore) and continues to look for an attractive entry point.

The seven brokers monitored daily by FNArena covering REA Group show five Buy or equivalent ratings and two Holds between them. One of those Holds is Ord Minnett (target $185), which has not yet updated on the result. The consensus target is $215.17.

Goldman Sachs believes 10% buy yield growth is achievable in FY25 even with a -2% geographical mix headwind. This broker notes REA remains confident on delivering double-digit earnings growth through the cycle.

Goldman has a Buy rating with a target of $221.

The outlier, with a target of $164, is Jarden.

REA assumes a flat outcome in FY25, with a small drag from geographic mix. If consensus follows this guide, along with larger associate losses and higher D&A, this is likely to drive downgrades to consensus earnings, Jarden suggests.

This broker believes REA is a high-quality business with strong management, a strong track record and a favourable outlook structurally. However, trading at 48x FY25 forecast earnings with a 15% compound annual earnings growth rate over FY25-27, valuation appears stretched.

Therefore, Jarden lowers its rating to an outright Sell from Underweight.

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