Treasure Chest: REA Group

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This story features REA GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: REA
The company is included in ASX100, ASX200, ASX300, ALL-ORDS and ALL-TECH

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Today's idea is 'REA Group'

By Danielle Ecuyer

FNArena’s Treasure Chest reports on money making ideas from stockbrokers and other experts.

Whose Idea Is It?

Bell Potter

The subject:

REA Group ((REA)).

An interest rate hiking cycle and the Federal Government’s proposed Budget changes for Australian property investors have created potentially adverse headwinds for Australia’s premier online real estate portal through lower listing volumes and falling dwelling prices.

This poses the obvious question: are forecasters ringing the bell on real estate stalwart REA Group following what some analysts have described as the most significant government policy change to Australia’s property and housing market in some thirty years?

More info:

The answer to the above question is a definitive yes, albeit with shades of grey when it comes to how much bad news is already discounted in the share price and just how much house prices are likely to fall.

Bell Potter’s latest view on REA has resulted in a considerable downgrade in terms of target price, valuation, rating and underlying projections.

Drawing upon prior periods of falling national dwelling prices in FY19 and FY23, the analyst highlights REA experienced listing declines of -8% and -12%, respectively. Those downturns resulted in residential segment revenue and group EPS declining by -9% and -8%, respectively, on a half-yearly basis.

The Budget tax changes around investment properties and the possibility of an additional RBA rate hike, following three cash rate hikes, are likely to have already dampened the two leading indicator markets, Melbourne and Sydney, where dwelling prices are nearing year-on-year declines as of May.

Both major markets typically lead the national housing cycle.

While REA has achieved positive residential revenue growth despite listing declines in eight of eleven interim and full-year results since 1H17, residential revenue declines resulted in group EPS falling in all three periods (1H20, 2H20 and 2H23).

Bell Potter points to a lag between changes in dwelling values and earnings.

Bell Potter has downgraded estimates for FY27 listings to -10% from -2%, previously, on the expectation the RBA hikes the cash rate again by September, followed by a cut around September/October 2027.

Notably, both owner-occupier and investor lending volumes experienced declining momentum in the recent March quarter, as measured by annual growth. Bell Potter anticipates a further fall in the growth rate or even a negative outcome by June.

Investor lending constituted some 40% of total new lending in FY26 up to March.

While the four-year fall in listings between FY17 and FY20 was offset by net yield growth, Bell Potter argues declines in average dwelling prices are a more important leading indicator for residential revenue, which contributes around 70% of group revenue. The flow-on effect would be a more sizeable impact on EPS.

Although management has some scope to manage operating costs, Bell Potter believes falling average dwelling prices will have a negative impact on volumes and most probably group EPS.

The stock is downgraded to Sell from Buy with a sharply reduced target price of $137 from $217, previously. The reduction reflects both a lower ascribed PER valuation multiple of 28x from 40x and a higher weighted average cost of capital.

The valuation of around 28x FY27 PER is typical of levels at which REA has historically traded during periods when EPS growth declines.

Bell Potter’s EPS forecast of -2% growth sits well below the consensus forecast of 14% EPS growth. Compared to classified peers on the ASX, REA also appears more expensive at 1.7x EV/FCF in FY27 versus Seek ((SEK)) at 0.8x and Car Group ((CAR)) at 1.3x.

A more moderate downgrade from UBS

UBS has come to similar conclusions after analysing what transpired during the macroprudential tightening cycle of FY18-FY19 when news headlines were dominated by the Banking Royal Commission.

UBS expects dwelling prices to fall by around -3% to -5% over the next year and forecasts another 25bps RBA rate increase, most likely in August, with rates remaining ‘higher-for-longer’ into 2027.

The outlook is more nuanced, with overseas inflation rising and other central banks likely to shift to a rate hiking cycle.

On the downside, UBS stresses the possibility the Australian housing market weakens “materially” due to the lagged effect of interest rate hikes, as well as the Budget measures. If house prices were to fall significantly, UBS explains the risk of RBA rate cuts in 2027 would increase.

Updated modeling has downgraded FY27 volume growth to -8% from flat, with an incremental softening of -2% into FY28 for a cumulative decline of -10%. The forecast decline is marginally higher than that experienced during the FY18-FY19 cycle.

Structurally, UBS proposes a shift towards more owner-occupiers, who have historically held dwellings for shorter periods than investors, might result in greater transaction churn over the longer term.

REA is still expected to grow revenue per listing by a strong 11% in FY27, but the broker is becoming slightly more cautious because agents appear less willing to increase spending on premium advertising products than they were a year ago.

Growth is increasingly reliant on the company’s ability to push through price increases rather than sell more premium products.

Earnings growth forecasts have been lowered by UBS on average by -9% over FY27-FY28 due to reduced volumes. The target price has been reduced by -23% to $165 from $213, previously, reflecting a lower earnings growth outlook and a reduced EBITDA valuation multiple of 18x from 22x.

Notably, the current REA share price implies volumes will fall by around -17% over the near term, which the UBS analyst considers overly negative.

In the absence of a near-term re-rating of the stock, UBS downgrades its rating to Neutral from Buy. Compared to global peers, REA is seen trading on a relatively full valuation multiple at 19x FY26 EBITDA against a rising risk of falling volumes and yields.

Morgan Stanley is prepared to buck the trend

In contrast, as argued by Morgan Stanley, the best time to invest in REA shares is during periods of cyclical weakness in listings. This analyst estimates around 90%-plus of all residential real estate sold in Australia is listed on the platform.

The link between the market, notably house prices, and what is transposed into listings is not deemed a linear relationship, Morgan Stanley argues.

REA is not directly “leveraged” to house prices, though historical precedent shows positive housing price growth generally coincides with stronger listings, while falling prices typically result in weaker transaction volumes and listings.

While noting the group’s 15% CAGR in revenue over the last decade, listing growth has not been the main driver. Morgan Stanley estimates total listings over the last 15 years have been broadly flat, with revenue growth driven primarily by monetisation of total “For Sale” listings through price rises, depth and premium products, and higher agent subscriptions.

Like UBS, this broker emphasises price, yield and new products as the key drivers of revenue growth.

Morgan Stanley’s base case for REA is new listing growth of negative -3% y/y in FY26 and 1% positive growth in both FY27 and FY28.

Any plus/minus 1% change in listings equates to a plus/minus 1% change in FY27 earnings (EBITDA) forecasts, on this broker’s modeling.

On a 12-month view, industry feedback has suggested the proposed Budget changes may result in an increase in residential activity as investors move to beat the proposed new deadlines, either through buying or selling investment properties.

Over the longer term, industry feedback suggests falling house prices because of the proposed Budget changes may diminish property’s appeal as an asset class. Declining house prices, less investor interest and more owner-occupiers may result in reduced turnover of total housing stock.

Morgan Stanley believes the greater risk to listings comes from RBA cash rate hikes. The broker accepts some near-term headwinds to volumes and consensus estimates, but retains confidence in its target price of $230 and Buy rating.

FNArena’s daily monitored brokers, including Bell Potter, UBS and Morgan Stanley, have a consensus target price of $195.264 with four Buy ratings, two Hold ratings and one Sell rating.

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