Despite looming headwinds, the REA Group reflects a strong Australian property market and the main problem for brokers is valuation.
– Integration of Mortgage Choice and REA India is going well
By Eva Brocklehurst
Australia's real estate sector remains resilient and Rea Group Ltd (ASX:) is a beneficiary. The company also benefits from its financial services division, which recently incorporated the Mortgage Choice brand, as well as REA India (formerly Elara).
Ord Minnett notes that the quarterly update was conservative in tone as the company anticipates some potential headwinds. These include potential regulatory action to address rising house prices, as well as the impact of the federal election in the fourth quarter of FY22.
Although cautious on valuation, the broker wouldn't be surprised if management upgrades the outlook as business conditions clear up after Sydney and Melbourne come out of lockdowns.
Morgans highlights strong sales growth for Mortgage Choice led by the REA Group, along with an increase in brokerage numbers, which the former entity struggled with. REA will incorporate the SmartLine brand into Mortgage Choice and full integration is expected in approximately 18 months.
The quarterly result was supported by housing supply and the impact of price increases in July. The depth recording was also better than expected. Supply grew 11% in the first quarter, while prices were 8% higher. Expense growth is expected to be in the high single digits, but Credit Suisse (SIX:) believes this will be more than offset by higher revenues.
Greater penetration depth is essential along with complementary products. The company did not provide specific growth rates for any of its divisions, but the indicted residential depth growth rate 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 notes that the growth is impressive. As the debt facilities have been refinanced and gearing remains low, the broker would not be surprised if further acquisitions were made , domestic or abroad.
Rating
Morgans continues to believe that REA is a top quality one-time venture on the ASX with its dominant market position and enhanced capabilities to expand its reach. On the other hand, there were some slight cuts in developer revenues and lower associates revenues during the quarter.
In addition, the broker believes that part of its current strength is simply listing forward, meaning upgrades are likely to be more muted in the longer run.
Despite the positive outlook, Morgans maintains a valuation hold rating and would aim to rally the stock below its target ($165.70). Macquarie's vision is also unchanged, believing that the shift to products with greater value and depth penetration is now reflected in expectations.
As a result, valuation support is believed to be diminishing. The broker maintains an Outperform rating and has turned slightly more positive on the listing outlook, although the approaching federal election could be a downer.
Management has indeed signaled that comparable volumes will become more difficult in the second half and that the timing of the federal elections may also have an impact. Still, Credit Suisse expects quotes to be strong at least in the second quarter, due to the reopening of Sydney and Melbourne.
Morgan Stanley (NYSE:) also believes Q1 earnings support his investment thesis, hailing a potential "super cycle" for REA earnings over FY22-23. This should be due to the list recovery in Sydney and Melbourne, higher turnover as Australians rethink their work/life priorities, as well as price increases and margin expansion.
While the company has not provided any explicit guidance, the broker expects that as first-quarter operating income (EBITDA) increased by 28%, growth of 11% over the remainder of the fiscal year is needed to achieve a full year consolidated EBITDA of $645 million.
Goldman Sachs (NYSE:) combines higher revenue growth with domestic spending assumptions to increase EBITDA estimates for fiscal year 22-24 by 1-5%. The broker, not one of the seven brokers checked daily in the FNArena database, has a buy recommendation and a goal of $193.
Ord Minnett claims that based on a set of metrics, REA trades a premium over competitor Domain Group (((DHG)) which is fully justified. The company differs in terms of business metrics and characteristics such as margins, operating cash conversion and free cash flow, yet the broker retains a Hold rating based on valuation.
FNArena's database has two Buy ratings and four Hold ratings. The consensus target is $169.03, indicating a -4.4% decline from the last stock price. The goals range from $145 (Ord Minnett) to $192 (Macquarie).
"Is valuation now the problem for REA Group?" was originally published on FNArena.com and republished with permission.
