Senior Equity Analyst
The Super Investor
8.00 am Aug 10, 2020
REA Group Ltd
How concerning is REA’s profit decline?
REA’s FY20 profit result announced on Friday ended a decade-long run of earnings growth. REA reported a 6% fall in revenue to $820m and a 9% drop in NPAT to $269m for the 12 months ended 30 June 2020. This was broadly in line with market consensus expectations. Cash conversion was strong and debt levels remain very low.
The whole year featured a very difficult backdrop, beginning with a fall in listings after tighter lending conditions following the Financial Services Royal Commission. This had started to recover in the early months of 2020 before COVID-19 put the brakes on the property market once again.
Pleasingly, REA did well in areas that it can control. The company was able to reduce its cost base over the short term to deal with the weak revenue environment, and other operational metrics around audience engagement and market share continue to trend in the right direction.
There is no evidence of any problem with REA’s business model or signs of competitive weakness causing the drop in earnings. It was just due to a very weak underlying property market.
New listings are weak
Depth penetration continues to grow
Market leadership retained
Capex was slightly lower than last year, and product innovation seems slightly lower than previous periods. It should be expected that when market conditions improve, investment in R&D will pick up again.
International yet to spark
Operating costs are planned to be flat for the full year, and the company expects to achieve “positive operating jaws”, meaning they should achieve an increase in margins. Given the difficult operating conditions, the company has decided to defer scheduled price increases until there is a sustained recovery in listings.
The market was forecasting a 9% increase in revenue and 11% increase in EBITDA for FY21 prior to this result. This seems slightly above the qualitative commentary provided by the company, and there may be some small downgrades to consensus numbers.
The median broker recommendation on the stock is Hold. This reflects the fact that the stock is well liked, but the high valuation and weak short-term backdrop have left analysts wary.
Forecast numbers currently back a strong rebound in listings and EPS over the next two years and a return to trend thereafter, which is needed to justify the current share price.
There are two reasons why the valuation may not be as unreasonable as the headline numbers suggest. First, Australian property listings are arguably at a cyclical low, perhaps 20-30% below trend. A return to more normal times could easily see EBITDA and profit increase over 30%, assuming consistent margins, so this part of the growth forecast looks reasonable.
Additionally, the international assets which include leading property portals in Asia and Move Inc in the US (REA purchased 20% of Move for $300m) are net contributing to small losses in the current year. There is value in these assets that is not being reflected in the multiples this year but may contribute material earnings in the medium to long term.
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